The Conservative Praetorian Guard massacres the pound
What did John Major’s Conservative Party and Caligula’s imperial court have in common? Extra-marital affairs and a contingent that assassinated the very thing they had sworn to protect.
“I learnt he'd gone to bed with my daughters. It was clear he relished the mother-daughter thing”—Valerie Harkess
Roman emperor Caligula, known for his licentious lifestyle and penchant for extra-marital affairs, would have been at home in the Conservative Party of the nineties. Caligula infamously slept with other men’s wives then bragged about it to them. He didn’t go as far as revealing his own affair with a mother and her two daughters in a squalid attempt to flog his presumably otherwise unsellable published diaries, but might have reveled in the intemperance.
In the imperial court of John Major, Tory MP David Mellor swapped togas for Chelsea shirts as his coital attire; MP Hartley Booth, a preacher who lied religiously and wrote mediocre poetry, was caught in an affair with a 22-year old researcher; and a Government Whip was caught in a “three-in-a-bed” romp with a Ministry of Defence official and an allegedly underage student at the London School of Economics.
But for their shared sexual interests, if Caligula were to drag himself from the Mausoleum of Augustus to attend the 1992 Conservative Party conference, there might have been a more uncomfortable familiarity with those around him.
Caligula was the first Roman Emperor to be killed by the Praetorian Guard, the soldiers sworn to protect his life. The assassination was particularly dark. The guards simultaneously butchered Caligula’s wife and daughter in a coordinated massacre of the emperor’s entire bloodline. A resurrected Caligula in 1992 might have seen the same the contrivance in the eyes of Conservative bigwigs, who on September 16, 1992 massacred the British pound they had promised voters they would protect.
Politics over policy
The events of Black Wednesday had their roots in the Thatcher era. In 1979, Margaret Thatcher inherited an economy that had suffered eye-watering inflation of almost 25 percent in the 1970s and saw it surge above 20 percent again a year later in 1980.
The spending cuts and interest rate hikes introduced in Thatcher’s first term thrust the British economy into a recession, curbing inflation, but at the cost of soaring unemployment. Interest rate cuts throughout the 1980s helped restore economic growth (although unemployment remained elevated) and inflation eventually stabilised under 10 percent. By 1988, the Thatcher government believed it had solved the underlying issues in the UK economy.
Thatcher’s three successive chancellors, Geoffrey Howe, Nigel Lawson, and John Major, all believed the best way to keep inflation in check was to join the European Exchange Rate Mechanism (ERM). The ERM linked Europe’s currencies to prevent large fluctuations in value and create a zone of relative monetary stability that would one day share a single currency. Europhiles also hoped that more exchange rate certainty would also deepen trade within the continent.
Despite the pressure coming from Number 11, Thatcher was reluctant to join the ERM and Geoffrey Howe and Nigel Lawson both either resigned or were removed from office after pressing her on the issue to no avail. But as her position as leader became more precarious in 1990, and pressure from Europhiles like Chancellor John Major was mounting, she relented and agreed to take the UK into the ERM that year.
In a moment of political grandstanding to wrestle headlines back from the Labour Party conference in October 1990, Major and Thatcher announced the pound would be pegged to the German mark at a central rate of DM 2.95. This meant the pound would trade within a fixed band of 6 percent in each direction around this point, allowing the pound to move freely between DM 2.78 and DM 3.13. All three main political parties supported joining the ERM in October 1990.
In their haste to announce the policy adjustment, Thatcher and Major had failed to consult ERM members about an appropriate entry level. Then-President of the Bundesbank Karl Otto Pöhl and others thought the entry rate was far too high.
Monetary policy 101
Why was the ERM a failure for the UK when other countries were able to benefit from greater exchange rate stability? There were two main reasons. But underpinning it all was monetary policy.
Monetary policy and bank interest rates are used to control the amount of money in circulation in the economy. In periods of high unemployment, the government or central bank can lower interest rates, which makes borrowing cheaper and reduces the financial rewards of saving. This encourages businesses and individuals to spend, thereby increasing the amount of money in circulation and stimulating growth and investment.
Increasing the amount of money in circulation, while useful for bolstering employment, can lead to higher inflation if unemployment falls below a level the economy can support. When inflation rises too high, raising interest rates reduces the amount of money in circulation by making borrowing more expensive and increasing the incentive to save, bringing inflation under control.
Effective monetary policy uses interest rate hikes and cuts to keep inflation in check, while promoting economic growth and maintaining a tolerable level of unemployment.
A moment of weakness
In 1989, a burst of higher inflation prompted the UK government to double interest rates from 7.5 percent to 15 percent. The effects of this interest rate hike were still working their way through the economy in 1990 when the UK joined the ERM.
The hike ended up being more than was necessary and threw the economy into a recession. Unemployment began to rise. Workers that had bought homes during the recent period of growth defaulted on mortgages and now lived in homes that were worth less than they had paid for them. Repossessions and bankruptcies soared.
As such, the British economy was not strong enough to support a central rate of DM 2.95 in 1990, let alone two-years later when the effects of the 1989 rate hike had fully materialised.
The British and German economies needed different things
Had the German mark and the British pound linked at a different time, the relationship might have been more serendipitous. But by 1992, the two economies were in different business cycles and each needed different policies and the union quickly soured.
The reunification of Germany after the Cold War had ushered in a period of rapid growth and higher inflation in 1991 and 1992. Germany’s central bank responded by raising interest rates, which made the German mark more attractive to investors looking for somewhere to park their cash. As investors flocked to the mark, its value increased.
Countries with currencies pegged to the mark needed to keep their exchange rates within their set bands and came under pressure to raise their own interest rates to keep investors attached to their currencies and hold their value.
This was a problem for Britain. To get out of its recession and reduce unemployment, it needed to lower interest rates and stimulate domestic demand, not raise them. Lowering rates, however, would cause investors to move their money elsewhere and cause value of the pound to drop, potentially crashing out of the ERM.
Crisis mode
Currency traders, including George Soros, smelt blood. They saw that the UK’s position was unsustainable and started to short the pound, initiating a depreciation in its value.
On September 5, Chancellor Norman Lamont urged the Bundesbank President Helmut Schlesinger to cut interest rates. He refused, worried that it would trigger an inflationary episode in the German economy.
As the pound collapsed, the UK government spent billions of foreign reserves buying Sterling in an attempt to prop up the currency, but it continued to plummet towards the DM 2.78 floor.
Even as late as September 10, Major and Lamont were still adamant that leaving the ERM and abandoning the pegged exchange rate would do nothing to help the situation. He dismissed proponents of leaving the mechanism as pedalling “quack doctor” remedies.
“The soft option, the devaluer's option, the inflationary option, in my judgment that would be a betrayal of our future at this moment, and I tell you categorically that is not the government's policy,"—John Major speaking at the Scottish CBI in Glasgow on September 10, 1992
The day of reckoning
On September 16, 1992, what would become known as Black Wednesday, the government was in full survival mode. As the currency’s value continued to plummet, it raised interest rates from 10 to 12 percent to try and shore up the pound.
When that didn’t work, Lamont announced a second rate rise to 15 percent that would come into effect the following morning. The Treasury and the Bank of England knew that if the government went through with it, it would be a death blow to the UK economy, unleashing a deep recession with staggering unemployment. In the end, rather than go through with such an extreme measure, John Major withdrew from the ERM that evening.
The next day, the government cut interest rates and continued to do so until they reached 6 percent in 1992. Home loans gradually became easier to finance, consumers had more money to spend, and the pound fell to a more sustainable level, making British exports cheaper and initiating a period of strength for the UK economy.
Conservative support fell faster than the pound
It is not an exaggeration to say that without Black Wednesday, Tony Blair may not have become Prime Minister. The Conservative brand suffered lasting damage. Public support evaporated almost overnight. In July, just before John Smith became Labour leader, the Tories had a small 4-point lead in the polls. By the end of September, Labour enjoyed a 22-point lead.
Major’s government had been humiliated. The Conservatives had promised voters it was the more trustworthy party on economic policy. The Labour Party was still haunted by its mishandling of the economy in the 1970s, the IMF bailout in 1976, and the deep cuts that followed. The Conservatives’ 1992 election victory was secured, in part, because the public trusted the economy in John Major’s hands. Despite the economic bounce after Black Wednesday, voters had not forgiven the Conservative government by the 1997 general election
The Conservatives had built their brand on the notion that they were the economy’s sworn protectors, shielding the pound and British businesses from the economic hurt inflicted by Labour’s daggers. In the end, it was their daggers that did the slaying and felled their election prospects in the process.