Why Thatcher gave in: Treasury papers reveal sorry saga

The story of how the Conservative government took the fateful decision to join the exchange rate mechanism and set itself on the road to financial disaster and political nemesis revealed in the official papers on Black Wednesday is a tale of a prime minister at odds with her chancellor.

It is also the tale of Treasury officials who failed to see what German reunification could do to the ERM; of bad advice from the Bank of England; of the pound being scuppered by the Germans. Above all, it is the story of how the Tory party condemned itself to the political wilderness when, against a background of mass unemployment and record home repossessions, the government spent $39bn (around £20bn) in a vain attempt at defending sterling on September 16 1992.

It is not yet the full story. Large chunks of the record published under the Freedom of Information Act have been withheld. But some gaps have been filled by documents erroneously sent to the BBC.

The long countdown to Black Wednesday began in the mid- 1980s. The documents recount how Nigel Lawson, then chancellor of the exchequer, decided that Britain should join the ERM. Margaret Thatcher, however, disagreed.

A paper from a senior Treasury official, Stephen Davies, written in 1993 and released yesterday, said the differences between Lawson and Thatcher became so pronounced that Lawson resigned in 1989.

One of the sections removed makes it clear that the removal of the prime minister's veto on ERM membership "was determined by her own increasing political weakness". Eventually, she did a deal with Lawson's successor as chancellor, John Major, and Britain announced its membership on October 5 1990 at a rate of DM2.95. As the Treasury later admitted - again in a deleted section - it was "not an optimal time" for the UK to join the ERM.

"No one in mid-1990s foresaw the interaction of falling house prices, negative equity, weakened consumer confidence and repossession that was to play an important role in determining consumer demand over the following two years," Davies says in his account.

Eventually, Thatcher's suc cessor, Major, and his chancellor, Norman Lamont, were faced with a dilemma. The recession at home required lower interest rates; the need to keep the pound within its ERM band required higher rates.

By the middle of August, the Bank of England was "seriously alarmed" about the pressure on sterling, but did not make clear that using Britain's reserves as a defence against the circling speculators might be throwing good money after bad. The immediate triggers for Black Wednesday were a devaluation of the Italian lira, and comments by the president of the Bundesbank, Hans Schlesinger - part of what the Treasury saw as a "whispering campaign for an ERM realignment".

With hindsight, the Treasury papers say, Black Wednesday was the best thing that could have happened to the UK. There would have been "very unpleasant consequences" for staying in the ERM - "what would have happened to the housing market does not bear thinking about". With interest rates coming down and a cheaper pound helping exports, the economy recovered. But the fortunes of the Conservative party did not.