Monday, October 12, 2015
Geoffrey Howe, exchange controls and the 1981 budget
Posted by David Smith at 01:00 PM
Category: David Smith's other articles


An extract from my book, Something Will Turn Up

The 1979 budget was big and bold. Rarely has a government set out its stall, and its philosophy, so clearly. The argument was that if these big changes had been delayed, they might never have happened, once events intervened. As significantly as the income tax cuts and the big shift from direct to indirect tax was another section in Howe’s speech.

Exchange controls had been the cross that British individuals and businesses had had to bear through sterling’s long period of vulnerability. During the worst of the country’s ‘sick man of Europe’ period in the 1960s, before and after the 1967 devaluation, a £50 ‘foreign travel allowance; operated, this being the limit on the amount of money British travellers could take abroad. That was probably the least important though most visible aspect of exchange controls. Partly to hold the Bretton Woods system together, most countries operated controls on the amount of capital that could flow in and out. For countries with vulnerable balance of payments positions, which could be exposed by flows of ‘hot’ or short-term money, such controls had come to be seen as very important. All that changed for Britain in the space of just a few months in 1979. In his budget speech, Howe said it was now ‘an appropriate time to start dismantling our apparatus of controls on outward capital flows’.

In his budget speech, Howe suggested that his approach to the removal of exchange controls would be a cautious one. It would be a ‘progressive dismantling’, he said, and determined by the strength of sterling among other factors. In the event, the chancellor was able to proceed a lot more rapidly than he thought. Just four months after his budget he announced to a surprised House of Commons that all the remaining exchange controls were to be abolished. This was quite a moment. Nothing better illustrated the commitment of the Thatcher government to free markets than this bold move to allow people and businesses to decide for themselves how to money across Britain’s borders.

It set the standard for the rest of Europe, which eventually followed suit by removing national exchange controls, though in some cases not for a decade or more. The Labour Party complained that it would cost British jobs, as firms used their new freedoms to invest overseas, although in subsequent years Britain was a net beneficiary of such flows, as inward investment increased sharply, particularly from the Far East. It also signalled to the world that the Thatcher government meant it when it said it would be radical and reforming.

The removal of exchange controls was one of the most important reforms of the Thatcher era, alongside other financial liberalisation including freeing the banks to enter the home loan market, the removal of hire purchase controls and the Big Bang reforms of 1986; which opened the City up to foreign ownership and brought the phenomenon of investment banks to Britain. A controlled financial system became a liberalised one, with both good and bad consequences.

Sir Geoffrey Howe, Margaret Thatcher’s first chancellor, was also the first chancellor I got to know on a personal basis. I was working for Financial Weekly, a now-defunct City newspaper. It had been launched, in 1979, by the then owners of the Daily and Sunday Express, with some fanfare. Money was spent on it, and high-profile columnists hired at considerable cost, including Harold Wilson, the former Labour prime minister. Later I was deputed, with a colleague, to take him to lunch in Westminster and tell him that we could no longer afford to carry his column, news he was able to avoid, on that occasion at least, through the simple expedient of not turning up.

Financial Weekly had failed to live up its founders’ expectations. When I joined in the spring of 1981 it was already clear that neither circulation nor advertising made it a viable proposition. A year later the original owners closed it and everybody received a redundancy cheque. It was a short-lived period of idleness. Two weeks later the title was bought by Robert Maxwell, the flamboyant Czech-born businessman and one-time Labour MP, today remembered for appropriating funds from his companies’ pension funds and dying, in 1991, after apparently falling overboard after a heart attack from his yacht, the Lady Ghislaine, which was cruising off the Canary Islands. That was much later. I remember him as a huge presence, literally, with a domineering manner. Anybody on the receiving end of Maxwell’s bullying, which I fortunately never was, did not forget about it in a hurry. As almost a comic-character magnate, he was also the subject of a lot of gentle mockery. One story about him, which I do not think was apocryphal, was of him coming across a member of staff in one of the corridors in Maxwell House (yet it was called that) on the north side of the City, smoking a cigarette while reading a notice board.

Maxwell, for some reason, took an instant dislike to the person, called him into his office and in his booming voice asked what his annual salary was. He them wrote out a cheque for the amount and told him never to appear in the office again. The man, it turned out, was not a member of staff but a visiting sales representative from another company, who had just enjoyed a large and unexpected bonus. In the meantime, a new proprietor meant a relaunch for the newspaper. We asked the Treasury if Sir Geoffrey Howe would agree to an interview, and he did.

Over the years, Howe has acquired a reputation as one of the most downtrodden political figures of recent times. In 1978, when he was shadow chancellor, he was famously the subject of one of the cruellest House of Commons putdowns of all time. Following an assault on his economic policies by Howe, Denis Healey, the chancellor, said that being attacked by his opponent was like being ‘savaged by a dead sheep’. Once in government, stories began to emerge of Howe being humiliated by Thatcher in cabinet meetings, and later some of those humiliations came out in some of her public utterances. It was no secret that she used her personal economic adviser, Alan Walters, and Sir John Hoskyns, head of the Downing Street policy unit, to bolster her chancellor’s resolve. At a time when the Treasury was resistant to the new government’s policies, she always feared that Howe would go native. One explanation of Howe’s devastating Commons’ resignation speech in 1990, which triggered the leadership contest that brought down Thatcher, was that it was his revenge for years of humiliation. He later denied that strongly, saying his speech was a matter of conscience. When I met him in 1982, it struck me that people had perhaps sometimes confused his courteousness with weakness. He was certainly courteous. When I said we were very pleased to have the interview for our relaunch, he said: ‘Do you think it will get on the front page?’ There was of course never any doubt that it would. The story, a variation on the theme that the economy was decisively on the up, fitted perfectly. That he was able to say in 1982 was far from guaranteed.

This was a year after Howe’s most dramatic moment as chancellor, his 1981 austerity budget. In the depths of the 1980-1 recession, he had turned the conventions of post-war economic policy on their head. Unemployment had risen above two million and was increasing by 100,000 a month. Though there was some tentative evidence that the pace of decline was easing, nobody could be sure that the economy was near a turning point. It was a moment when most governments would have trod carefully, for fear of making a bad situation worse. Instead Howe, egged on by Thatcher and her advisers, unveiled a budget that even with the passage of time looks bold, to the point of foolhardiness. Had it gone wrong, it could have been the end of the Thatcher government.

Though Keynesian economic policies had been abandoned by the Callaghan government in 1976, they were buried by Howe in 1981. His budget raised taxes, mainly by freezing personal tax allowances at a time of high inflation, raising employee National Insurance contributions and announcing big increases in excise duties on petrol, alcohol and tobacco. Popular it was not, even though there was a one-year windfall levy on the banks, which were benefiting from the very high interest rates that were part and parcel of the government’s monetarist experiment. Most notoriously the budget produced a response from 364 economists, a round-robin letter circulated around university departments which was published in The Times, which condemned the government’s approach. The letter, initiated by Frank Hahn and Robert Neild of Cambridge University, two of Britain's most distinguished professors of economics, attracted the signature of four former chief economic advisers to the government, and one future governor of the Bank of England, Mervyn, later Lord, King. ‘There is no basis in economic theory or supporting evidence for the Government's belief that by deflating demand they will bring inflation permanently under control and thereby induce an automatic recovery in output and employment,’ it warned. ‘Present politics will deepen the depression, erode the industrial base of our economy and threaten its social and political stability.’

The letter could have been an epitaph for the Thatcher government’s economic experiment. The story goes that when Michael Foot, the Labour leader, asked her in prime minister’s question time to name two economists who agreed with her policies, she was able to say, quick as a flash, Walters and Patrick Minford. But in the car back to Downing Street she turned to an aide and said: ‘It’s a good job he didn’t ask me to name three.’ 1981 was certainly the government’s toughest year. Just a month after the austerity budget the first of the inner-city riots broke out. The riots, in Brixton in London, Toxteth in Liverpool, Chapeltown in Leeds and Handsworth in Birmingham, appeared to be a direct response to high and fast-rising unemployment, though subsequent investigations showed that the causes were more complex. For several months the austerity budget appeared to be a gamble that had failed. Though it is now seen as one of the episodes that were the making of the Thatcher government, it did not look like that for some time. Figures now show that the 1981 budget did mark the low-point of the recession, and that the 364 economists were wrong. By focusing on fiscal policy – the budget measures – they had failed to spot that the purpose of the budget was to make space for a relaxation of monetary policy. Howe was able to announce a two-point cut in interest rates in the budget and in subsequent months it became clear that the government had moved away from its initial very tough monetarist approach, which Healey had christened ‘punk monetarism’. The pound came down in response, easing some of the pressure on industry. Inflation also began to fall sharply, easing the pressure on living standards. Monetary policy revealed itself to be more powerful than fiscal policy, establishing a pattern for economic policy that was to become the norm.