Lord Lamont: Yes, Britain benefited from getting out of the ERM, but we also first benefited from being in it

On the twentieth anniversary of Britain's departure from the Exchange Rate Mechanism, Lord Lamont, the Chancellor of the time, busts some myths about the episode and its aftermath.

(1) “Didn’t Britain lose £30bn of reserves during the ERM crisis?”

No.  There were many exaggerated estimates put around at the time.  When foreign exchange reserves are used to support a currency, the money is not “lost”, it is swapped for another currency.  Britain spent almost all its reserves as did countries like Italy, Ireland, Portugal, Finland, Sweden, Spain and France during the crisis.  The correct measure of the loss is the amount of foreign exchange reserves spent, divided by the percentage fall in the currency. In Britain’s case this came to about £3bn.  The reserves are not money that could have been spent on roads and hospitals, they are specifically for foreign exchange transactions. The “loss” on the reserves was made up in a few years as Sterling recovered its strength against other currencies.

(2) “A break up of the ERM was always inevitable”

Fixed exchange rate systems do not always break up. The ERM had existed since the early 1970s as a fixed but adjustable system of exchange rates.  There had been no crises throughout the 70s and 80s. What broke the system was German reunification which created a boom and raised interest rates throughout the ERM countries.  What is often forgotten, is that public support for joining the ERM in 1990 was widespread in the press and business.

(3) “Britain was ejected from the ERM”

This phraseology is not quite right.  What happened was more a break up or implosion of a system. Seven other countries spent almost all their reserves and devalued or floated their currencies at the same time as Britain. Most of them eventually decided to rejoin the ERM after the markets settled down. But Britain did not. In the summer of 1993, the crisis resurfaced and currencies floated within wide bands. The ERM virtually ceased to exist for a while.

(4) “The ERM resulted in our putting up interest rates” 

During the whole of our membership other than on September 16th itself, interest rates were only cut and never increased. Rates went from 15% to 10%. On September 16th, rates were announced as going up to 15% but this did not happen.  Rates were put up to 12% but cut again the next day. Of course, after inflation had come down rates were too high for the UK and many other countries which is why the ERM broke up.

(5) Mrs Thatcher would never have joined the ERM.

A commitment to joining had been Conservative policy ever since 1979.   It was in fact Mrs Thatcher as Prime Minister and John Major as Chancellor who made the decision to join the ERM.

(6) The exit was a national humiliation.

If it was humiliation, it was also one for Italy, Sweden, Finland, Norway, France Spain, Portugal and Ireland. All countries other than Germany and its economic satellites had the same experience.

(7) The ERM was of no benefit.

As I say in my article in the Sunday Telegraph;

“The myth beloved of the Conservative media is that the economy was, from the very beginning, throttled by the ERM until with one bound, it was freed and everything moved into the Promised  Land. People forget why Mrs Thatcher and John Major joined the ERM in the first place:  It was to get our inflation rate down and, indeed, the ERM reduced our inflation from double figures to under 2% shortly after we left. Without that dramatic fall, it would not have been possible to have had the strong recovery of the 1990s.

Britain would never have had such a de-escalation of inflation without the framework of the ERM. The Government simply would not have had the determination to maintain the high rates of interest necessary.

The ERM broke down because of German reunification which created a German boom and rising interest rates.  Once Britain’s inflation had been reduced, German dominated interest rates were no longer appropriate and lengthened the recession but not by very much.  Yes, we benefited from getting out of the ERM, but we had also first benefited from being in it.   For this reason, Sir Alan Budd, in his Wincott Lecture, said that the experience of being in the ERM marked a turning point in Britain’s economic performance which lasted over a decade – a text book recovery, low inflation with falling Government deficits and accelerating growth”.

Unlike today,  when  the economy is still below its pre-recession peak four years after the recession began, by 1993 the economy had outgrown its pre-recession peak.