The ERM crisis (1992)

Before we delve into the ERM crisis, let’s recap, by pointing out some key characteristics that the previous crises in this series have all seemed to share.

1.) The Pound slides during times of crisis - no going back to the heights of the Victorian era

2.) Inflation often posed a problem during each crisis - not necessarily because of devaluation

3.) The party in government suffered some kind of backlash, either through electoral defeat or the ousting/departure of the incumbent Prime Minister

4.) British productivity is far weaker than elsewhere

With these points in mind, let’s examine the UK’s entry and chaotic exit from the ERM.

Thatcher - Rise and Fall

In the last post, we explored the end of the stagflationary crisis of the 1970s, which saw the rise of Margaret Thatcher. The new Thatcher government broke with the post-war consensus (full employment), forging a new one based around price stability.

Unemployment stopped being viewed as a social evil that had to be avoided, and seemingly became a sacrifice that had to be made, in order to bring inflation back down again. The policy was criticised for doing irreparable damage to the social fabric in industrial areas as a result of high unemployment

Simply put, the 1979-81 recession didn’t have to be as deep as it was, but the government thought short-term pain was the only way to ensure long-term gain.

Splits within the Labour opposition in 1980-81 led to the party losing MPs, who went on to form their own party, the SDP. The SDP ultimately won 7 million votes in the 1983 election, but due to the structure of British political election arithmetic, they barely won a handful of seats.

Labour’s crisis enabled the Tories to try and capture disaffected voters with enticements such as home ownership and the prospect of privatising industries, to enable the ownership of shares. The consequence of this was an increasing reliance on credit, a booming stock market, and a new generation of Brits seeking to make their fortunes.

For a time, the Conservative government seemed relatively stable. Mrs Thatcher avoided an assassination attempt when the IRA bombed her hotel during the 1984 Conservative Party conference in Brighton. A miners’ strike in 1984-85 failed to cripple the government in the way it might have done in the previous decade.

The Conservatives had won a larger majority in 1983, and won a third victory under Mrs Thatcher in 1987, as the economy began to boom. Mrs Thatcher’s Chancellor of the Exchequer, Nigel Lawson, slashed taxes in 1987, allowing the economy to surge.

The government believed the 1980s recession had raised productive capacity, allowing the economy to boom for longer without inflationary pressures building up. This was effectively a precursor to a future Chancellor’s claim that boom and bust was a thing of the past. How wrong this would prove to be.

The Lawson boom had proven to be yet another bubble, and Lawson was forced to raise rates to stop inflation getting out of control. Due to personal differences, Lawson ultimately left Number 11, replaced by a fairly unknown man called John Major.

By 1989, Mrs Thatcher was losing the qualities that had earned her the unwavering respect of her parliamentary colleagues. Cabinet ministers grew increasingly concerned about the direction the government was heading in.

The ERM

In her final weeks in Number 10, Mrs Thatcher’s government oversaw the UK’s entry into the Exchange Rate Mechanism (ERM). This meant that the UK had entered a system in which European currencies moved around in a price corridor. The ultimate goal was to co-ordinate them all, so that they would ultimately merge with the Deutsch Mark, to form a single European currency.

Mrs Thatcher had become increasingly Eurosceptic in her final years as Prime Minister, concerned that the European project was beginning to usurp the power of individual member states. Her Euroscepticism combined with her crusade to introduce a new Poll Tax, one of the most controversial policies of the 20th Century.

Within a month of the UK entering the ERM, Mrs Thatcher faced a leadership challenge from former Cabinet minister Michael Heseltine, and despite winning more votes than her rivals, she didn’t win enough to remain secure. Convinced by colleagues that her power was ebbing, she resigned. John Major ultimately entered the fray, as an apparent successor, and succeeded her.

However, John Major was far from the heir to Mrs Thatcher. By November 1990, the UK was in the grip of a new recession. The Japanese economy was reeling from the bursting of a property bubble, sending shockwaves across the world. The UK, locked into the ERM, was limited in how much it could ease monetary policy, as this risked causing the Pound to fall out of the ERM price corridor with the Deutsch Mark.

By 1991, the economy began to grow again, and despite continuing economic malaise, Major managed to secure a fourth election victory for the Conservatives in 1992, with over 14 million votes. Labour leader Neil Kinnock, who had led the opposition since 1983, had believed he had a chance of winning, but the 1992 defeat was crushing, and he resigned, succeeded by John Smith, a shadow Cabinet minister.

The Conservatives seemed to have seen off the opposition, but this was when the real crisis began. Norman Lamont was now the new Chancellor, but the crisis that followed would ensure that his tenure at the Treasury was a short one.

The economy remained weak for the duration of 1992, but the government didn’t want to risk ERM membership by cutting interest rates too suddenly. By the early 1990s however, it became easier for speculators to sway sentiment in the currency markets.

The Pound faced intense speculative pressures as summer turned to autumn, particularly as investor George Soros had been expecting the Pound to sink. He began to build up a significant short position in Sterling, leading up to September 1992. According to Soros, UK entry into the ERM was wrong-footed, as the Pound was overvalued, and that it would have to devalue.

In mid-September 1992, Soros broke cover, selling $10bn of Sterling holdings from his fund. The Major government, trying to save face, initially tried to protect the Pound and maintain ERM membership. To do so, they believed the Pound had to remain elevated, so they spent millions of Pounds worth of reserves, but to no avail.

The Pound tumbled, and the government briefly hiked interest rates as high as 15% to keep it in the ERM corridor, but soon reversed the decision, keeping rates where they were. Senior Cabinet ministers, including Major, Lamont, Michael Heseltine, Kenneth Clarke and other colleagues convened, to find a solution. They ultimately decided an exit from the ERM was the only viable option.

Italy, also a member of the ERM, had seen the Lira breach the price corridor at the same time as the UK, but ultimately managed to remain in an adjusted form of the ERM, in which the corridor was broadened. The UK exited the ERM, but never returned. Pro-Europeans viewed the exit as a humiliation, whereas more Eurosceptic people viewed it as a liberating moment for Britain.

Voters made up their minds relatively quickly. A sitting government had just tried and failed to protect the Pound from currency speculators. As a result, the UK had ended up crashing out of the ERM, signalling a shift in policy they hadn’t expected to make, at a time when unemployment remained close to 10%. Voters vented their frustration, with the Conservatives crashing in ensuing opinion polls.

Disunity over ever-increasing unity

Major’s government lost a great deal of support from the public, following the ERM crisis, and never recovered. Despite winning 14 million votes in 1992, the Major government had a miniscule majority of 18 seats. This left Major vulnerable, if his MPs should decide to rebel against any policy of his. This ultimately came to pass in 1993, with the ratification of the Maastricht Treaty in Parliament.

As many as 22 backbench rebels, from the increasingly vocal Eurosceptic wing of the party, received encouragement from Mrs Thatcher, and did everything they could to sabotage the ratification of this new treaty, that would embolden the European Commission, and oversee the formal establishment of the European Union.

Maastricht was the roadmap towards increasing integration in Europe, in a way that inflamed tension within the Conservative Party. Eurosceptics, who had always been present within the party, now refused to fall in-line and believed the project was a threat to British sovereignty, eroding the power of member states, in their opinion.

The Maastricht Treaty was ultimately ratified, but not without caveats for the UK. The UK would not be part of the currency union, along with a number of other structures. Major had managed to ensure the UK remained close to Europe, but not quite as close as it could have been. Even by doing so, the Conservative Party was still fractured.

Major grew weary of rebellion, leading him to decide to resign as party leader in the summer of 1995, offering his critics to challenge him for the leadership directly. John Redwood, then-Secretary of State for Wales, jumped at the opportunity, resigning his post to run against Major. However, Redwood ultimately failed, setting the Eurosceptics back for years. 

Major was able to retain his support among his own MPs, remaining in office as PM and party leader. However, the Conservative Party was now riven with divisions, and Labour was now increasingly viewed as a suitable alternative party of government. Labour was briefly shocked by the sudden death of leader John Smith in 1994. 

The party mourned Smith's untimely passing, but the party was now less riven by divisions, having apparently learnt its lesson after over a decade in the wilderness. Tony Blair ultimately succeeded Smith, seeking to reach out to disaffected voters through political triangulation. Blair sought to seek a third way in British politics, and Labour enjoyed a sizable poll-lead over the Tories for the remainder of the 1990s.

The 1990s were a watershed moment for Eurosceptics. They believed the UK was hurtling towards an ever-increasingly complicated union that was no longer deemed suitable for UK purposes, in their eyes. 

Alan Sked, a lecturer at the LSE, had founded the Anti-Federalist League in 1991, but by 1993, he assembled with like-minded individuals, to form a new force, UKIP, the UK Independence Party. Its sole ambition: to ensure the withdrawal of the UK from the EU.