By Frank Noakes
and Catherine Brown
LONDON — Even by its own criteria, the British Tory government is an economic failure. Talkback radio programs have been inundated with questions from a British public still in a daze from four changes to interest rates in less than 24 hours. Economists on the various news programs dare not predict future developments as confusion reins; and the only smiles visible on television were those on the faces of the money market brokers.
September 16 will enter the history books as the day the Tories' demigod, the sacred "free market", turned against them, destroying entirely the government's economic policy. ("Policy" is a generous term for essentially doing nothing other than cutting back on government spending.)
The financial markets determined that the pound was overvalued, hiding within the confines of the European Exchange Rate Mechanism (ERM).
In 1979 the European Community established the European Monetary System to bring about cooperation between monetary authorities. Exchange rate stability is supposed to be ensured through the ERM, in which currencies are prevented from diverging from each other by more than an agreed percentage.
Major and the chancellor of the exchequer, Norman Lamont, had decreed that the pound would maintain parity with the German deutschmark come what may. Their exalted market called their bluff.
First the government, through the Bank of England, bought up to £10 billion of sterling with its foreign currency reserves to keep the pound from falling below its ERM floor of DM2.77: the government can't find the money to finance public works programs, it claims.
This intervention failed, so interest rates were increased by 2%, to a base rate of 12%. Having again failed to halt the run on the pound, the government lifted the rate by a further 3%. This was the first time in the Bank of England's 300-year history that it had been directed to increase interest rates twice in one day.
Lamont having played all his cards, the market moved in for the kill, many dealers and speculators making a handsome profit. The government was then forced to do what it said it would never do: suspend the pound from the ERM and allow it to float — although "float" doesn't really capture the motion of sterling; "sink" would be more apt.
Later, in the evening of that day, Lamont cancelled the increase of 3% and the following day cancelled the other 2% rise in interest rates.
The markets knew that the 15% interest rate could not and would not be already suffering its worse recession for 60 years, with high house repossessions, record numbers of businesses bankrupt, official unemployment approaching 3 million and some banks on a knife edge with "non-performing" loans. A sustained rise in interest rates could produce an explosive economic and social catastrophe, with unemployment possibly exceeding levels of the Great Depression.
'Circle of chums'
Major and Lamont have come under political pressure for their mishandling of the economy — but less from the opposition parties than from within their own ranks, from the "Euro-sceptics". The Guardian in its September 17 editorial states that the Cabinet are equally culpable and adds, "But so, too, are the major parties of Opposition. John Smith and Gordon Brown [Labour leaders] have a range of peripheral alternatives and an ancient critique of Tory policy. But, on devaluation and the sanctity of the exchange rate mechanism, there's been nothing you could call a difference. They're in this together as well. So with zealous fervour, are the Liberal Democrats. A wider circle of chums."
Ken Livingstone, a left Labour MP, points out that it was the Labour Party leadership that harried the Conservatives into joining the ERM in the first place. Britain joined in October 1990.
In an article published in Socialist Campaign Group News, before the run on the pound, Livingstone explained a little of the background:
"The ERM means that British monetary policy is determined by the German Bundesbank. For most of the last decade the German trade surplus subsidised the rest of Europe, including Britain's trade deficit. But today Germany is running a trade deficit sucking capital into Germany, to finance the unification with the east. This requires high German interest rates no matter what the consequences for the rest of Europe.
"The ERM means that high interest rates in Germany have to be duplicated throughout Europe to maintain currency parities ... The result is that Germany is holding the whole of Europe in recession, creating mass unemployment, weakening the trade unions and allowing racism and xenophobia to flourish."
Farewell to TINA
The Tories believed their own propaganda. But it is a sad indictment of the opposition that it too accepted, as received wisdom, the Thatcher nostrum: TINA — There is no alternative.
With the pound falling, imports will cost more, causing a further decline in the standard of living for most working people. British manufacturing — weak, inefficient and starved of investment — is not, in the main, in a position to replace imports; and because the rest of Europe, and the world for that matter, is in recession, it products on overseas markets.
Cambridge professor of applied economics Wynne Godley, gave a nice twist to a famous remark of Keynes, announcing, "In the short term, we are dead". Godley predicts that continued high interest rates, particularly if they are raised, will mean "the entire fabric of the financial system is in imminent danger of collapse". Godley says that, even before the sterling crisis, "The present recession was one from which no recovery worth the name would ever occur".
This, explains Godley, is due to the enormous debt overhang accruing of both individuals and companies — well in excess of £400 billion, or more than one year's personal consumption for the country.
Many home buyers now have mortgages higher than the value of their home. At the same time, more than 1500 people lose their jobs each day. Consumer confidence is shattered.
In or out of the ERM, the British economy is on a recessionary slide. The real problem for the government is there is no solution without tackling the more fundamental social and economic problems.
'No hiding place'
Livingstone suggests a way forward: "Reduction in interest rates, devaluation, expansion of public investment and reduction in military spending to finance this — are the main planks of the left's economic alternatives. The left should take great confidence from the fact that recent events have once again proven that policy to be correct."
French economist Jean-Paul Betbeze claims, however, that "Even if you are not in the ERM, you are not outside the German monetary area, and this is a zone of high interest rates. There is no hiding place."
But regardless of how the French vote on September 20, European monetary union lies in tatters. Britain and Italy are, at least temporarily, out of the ERM, and Spain has devalued. Now the Irish and Swedes are in the financial markets firing line: Sweden has raised the top of the market interest rate to 500% to protect the krona against speculators!
The crisis may now allow the European left the space that it so far has been unable to make for itself; much of the opposition to the Maastricht Treaty has been credited to the extreme right. Maastricht is an unmitigated disaster for working people. The left and progressive movements need to work together for a European unity of a socially rational and equitable kind.