Currency Stability

HL Deb 05 March 1985 vol 460 cc1274-302

7.32 p.m.

Lord Diamond rose to ask Her Majesty's Government what steps they are taking to ensure reasonable stability of the currency.

The noble Lord said: My Lords, I preface my remarks by expressing my appreciation to the Government for having facilitated this debate and my appreciation to the noble Earl, Lord Gowrie, for his presence here to deal with what is, in my view, a matter of considerable importance.

I start as usual on common ground: that governments throughout the world desire to have so far as possible reasonable stability in their currencies. This is especially the case for a great trading nation like ours. As regards industry, it is in the special difficulty that it cannot plan investment unless it has this stability; and investment of course affects employment, output and exports. In relation to that, I quote a statement made as recently as the beginning of this month by the Director-General of the Institute of Export, who ought to know what he is talking about. He said: It is the view of this institute that stability in exchange rates is more important than particular levels. Developing a market is a long-term business, taking three, four or five years. That can all be wiped out by violent swings in the exchange rates". If one needs further confirmation, the president of the CBI said something very much the same a few days earlier when he said that exchange rate stability, was more important than the actual value of the pound and could best be achieved through membership of a wider exchange control system".

Therefore, it is clear that the Government have desired reasonable stability, but regrettably it is equally clear that they have failed to achieve it. Since its peak in October 1980 the pound/dollar rate has fallen by over one-half, as we all know. From over 2.40 dollars it fell remorselessly month after month and it now stands at around 1 dollar 6 cents. Partly that reflects the strength of the dollar, and partly it reflects the weakness of sterling. Therefore, it would be fairer to have regard not merely to one exchange rate but to what is usually called the basket of currencies. That gives a fairer impression of what has happened to sterling. There is an index which, as we know, started in 1975 at 100. It was 100 five years later in 1980, but since then it has fallen to 71—a drop of nearly 30 per cent. That is the answer to those who claim that this exchange rate instability is purely a phenomenon of the dollar.

So far as the effects of instability are concerned, is it possible to give the House some measure of the cost? Indeed, it is. The authoritative answer is given in the 1984 OECD annual report which estimates the effect on employment as being 10 per cent. of the decline; that is, the instability and volatility of exchange rates in this country during the present Government's tenure has cost the country some 200,000 to 250,000 jobs. That is due to instability in the currency and refers to the past, but what of the future? The Times has calculated on the Treasury figures that the depressing effect of the consequences to the base rate increases—I refer to the base rate increases in January of this year—if not reversed could reduce the gross domestic product in 1985 and 1986 by between 1½ per cent. and 2 per cent.: that is to say, around £6 billion each year, with its consequential toll of even further unemployment.

What, then, are the reasons for this unwanted volatility? The reasons are complex and numerous, but they can be summed up in one answer: the loss of confidence abroad in the Government's economic policies. Those individuals who are responsible for the sentiment in the various markets do not, as we do, have the privilege of listening to economic Ministers coming to the Dispatch Box time after time, sustained by their self-deceptive selection of some of the statistics, claiming success after success and offering us a rich diet of what I can only call "fudge".

The markets' sole concern is the reality of the situation and to begin with the markets welcomed the arrival of a Conservative Government, as they also welcomed more and more oil wells coming on stream, and for a year sterling rose. But then hesitation set in and the pound began to falter. As confidence ebbed, so did sterling; for the markets saw a Government squandering the benefits of that oil and replacing the nation's rich heritage with—nothing! They saw our manufacturing industry being slimmed down until it was a pale shadow of its earlier self, too weak to export enough to pay for the country's manufactured imports. They saw the daily diminution of the nation's potential as unemployment rose and rose and never fell. They saw the national product growing, on average—I repeat, on average—at the appallingly low rate of half of 1 per cent. per annum; and they saw huge, self-inflicted gashes like the miners' strike festering and never healing completely.

Not surprisingly, confidence in sterling continued to fall. The one thing that could have halted and perhaps reversed the economic decline—an improvement in international competitiveness—never occurred. It had been headlined by the Government as important, but it had not been helped. The figures are conclusively set out in a most comprehensive report prepared by the non-profit-making European Management Forum. That report shows, as one would expect, Japan, Switzerland and the United States holding among them the first three places in successive years. Germany was fourth, and remains fourth. The United Kingdom was 14th, and remains 14th.

I have described the reaction of the international markets. I come now to the way in which the Government have reacted. Perhaps I could describe them as having reacted with their customary courage and steadfastness. From the start, they courageously turned their back on the financial markets and said that exchange rates were not a matter for the Government. They steadfastly continued in that posture notwithstanding that sterling continued to sink. To make matters worse, they let it be known that whatever happened they were not going to seek to affect the exchange rate, which was of course sweet music in the ears of potential speculators.

But in January of this year everything changed. The spectre of pound-dollar parity began to haunt the corridors of No. 10, and so, in the absence of any long-term plan, something had to be done quickly. There followed a spate of activity in a great variety of directions. We all know that the Prime Minister likes clarity, so there was a clear statement to the press from No. 10. There was also a clear statement to the press from No. 11, albeit saying something totally different.

Then the Chancellor made it clear that joining the EMS would have made no difference, while the Governor of the Bank of England, the authority on the financial markets, who always works in the closest collaboration with the Chancellor, or who did in my time, made it clear that joining the EMS would have made a lot of difference. Then an economics Minister in the Cabinet—none other than the one who is gracing the Front Bench opposite at the moment—pointed out that as a petro-currency sterling is naturally sensitive to rumours about oil prices. This was followed by another Cabinet Minister—no less a person than the Minister responsible for the "petro" part of the equation—saying, "Such an argument does not bear examination".

But there were in fact two senior Cabinet Ministers who actually said the same thing. Mr. Lawson and Mr. Walker both insisted that everything that they, the Prime Minister and their Cabinet colleagues had been saying for five years about leaving it to the markets was mistaken. The markets, they said, could be wrong! To cap it all, the Government had three bites at base rates. Within the space of two-and-a-half weeks they raised them by a total of four-and-a-half points, or nearly 50 per cent.; and yet the sterling-dollar rate now stands at around its all-time low. What a sorry spectacle of muddle and fudge! It is not surprising that the Chancellor of the Exchequer has been strongly criticised by the all-party Select Committee on the Treasury in the other place.

I hope the Government have now had time to pull themselves together and to decide on their policy to meet what is an undoubtedly serious and difficult situation. I hope that this debate will give them an opportunity to state in some detail, as far as is consistent with the national interest, what steps they propose in the furtherance of that policy. Two steps I hope they will not take. What I hope they will not do is to parade a series of carefully selected and partial statistics related to irrelevant base dates, seeking to show that all is well and that, as the Chancellor recently claimed, the economy is "on course". That kind of statement persuades nobody either inside or outside the country, and merely demonstrates the total incapacity of the Government to measure up to the seriousness of the present situation and their responsibilities.

What I also hope that the noble Earl and the Government will not do is to continue to rely exclusively on the line so far taken that the Government will continue to give overall priority to reducing the rate of inflation. Although that is a desirable end in itself—I do not wish to be misunderstood, so I repeat that that is a desirable end in itself—the outside world is not much impressed by the achievement of a reduction of 50 per cent. in the rate of inflation at the cost of an increase of some 250 per cent. in the number of unemployed and at the cost of the decimation of our manufacturing industry. This must be evident from the fact that over the past four years a consistent reduction in the rate of inflation has been accompanied by a consistent and dramatic fall in the value of the pound.

But what I hope the Minister will include in his reply are several steps, each of which have been recommended by one or other of two Conservative ex-Prime Ministers. The first, which my noble friend, Lord Ezra, will explain in more detail, is joining the EMS, or perhaps I should say the ERM—the European Reserve Mechanism—as strongly urged by Mr. Heath and, of course, by the Alliance parties, as spoken of approvingly by the governor and an ex-governor of the Bank of England, and as recently strongly urged by the CBI. It would be just the step needed at present, giving us extensive mutual currency support, while at the same time encouraging those very disciplines which are very beneficial to our economy. If I may quote from a recent speech of the President of the EC, he said: The EMS has been an area of relative calm in a sea agitated by the wide and sudden fluctuation of currencies".

The other steps are even more far-reaching, for what is in question, in my view, is nothing less than the confidence of the world in the ultimate strength of the British people and the British economy. For our revival or renaissance, as it has been called, we need, as the noble Earl, Lord Stockton, recently indicated, to stop relying exclusively on monetarism and, as I think, to relegate it to its proper place as only one of a number of aids to good government. We need to look at the reality of the situation with employment at intolerably and unnecessarily high levels. We need to have the good sense to borrow responsibly in order to start rebuilding the economy; and we need to remember the essential difference between capital and current expenditure lest we be all condemned to finish our lives in those dreary lodging houses.

7.51 p.m.

Lord Bruce-Gardyne

My Lords, I am sure your Lordships will all wish to congratulate the noble Lord on raising this highly topical question tonight. It might be said that if he had had one of his earlier dates for the subject it might have appeared even more topical but that was beyond his power to command.

Studying the Question that he had placed on the Order Paper, I could not help recalling an account I heard many years ago when I was working in Paris. It was an account of a meeting of the committee which was established towards the end of the war to consider the re-establishment of the French economy once the war was over. It met on one occasion at the Elysée Palace. While they were waiting for General de Gaulle to arrive, one of the more prominent but perhaps less intellectually endowed of the resistance leaders was saying, "It is very simple, gentlemen. All we have to do is to eliminate all the shysters"—the word that he used was not quite "shysters" but I do not think the one he did use would be appropriate for this illustrious Chamber. At this point a large nose poked round the door and a voice was heard saying, "A vast programme, gentlemen."

It occurred to me that there was something almost vast about the call that the noble Lord was making to the Government to ensure reasonable stability of the currency. I recall that in the days when we had the régime of so-called fixed but adjustable exchange rates we used to be told that the move to floating rates would solve everything from stop/go to acne. Unsurprisingly, it did not quite work out the way that its protagonists expected. Nowadays it has become deeply fashionable to blame all our ills from stop/go to acne on the existence of floating rates. I have to say that I am not at all clear whether or not they really bear the burden of responsibility which is placed upon them.

I must confess that, after listening to the noble Lord, I am no more clear than I was before as to how the genie of fixed exchange rates, having been ejected from the bottle in 1970 to 1971, can now be reinserted whence it came. I must confess I was slightly surprised by the line that at least parts of the noble Lord's speech took. I had certainly expected a call for us to participate in the exchange rate mechanism, and that was indeed forthcoming.

If I may, I should like to revert to that in a moment. But, before then, we had the explanation of the grave lack of exchange rate stability from which we have been suffering. If I understood the noble Lord correctly, it was that there was a loss of confidence abroad in the Government's economic policy. If it be true that the equally vertiginous decline in the exchange rate of the deutsche mark vis-à-vis the dollar, or the exchange rate of the French franc vis-à-vis the dollar, is to be attributed to a loss of confidence abroad in this Government's ecomomic policy, then my right honourable friends have powers of influence in the world which I must say I had never dreamed of attributing to them.

The truth is that if we look back to the point at which the exchange rate mechanism was established, back in 1978, there is a striking degree of stability between sterling and the participant currencies in the exchange rate mechanism. When the ERM was set up, the sterling exchange rate for the deutsche mark, as I understand it, was, 3.80. Today it is about 3.60. During that period there was a peak appreciation of the pound in terms of the deutsche mark of 15 per cent. and, since then, a decline of 18 per cent. Of course, as the noble Lord will be aware, the fluctuations in the case of the French franc have been very much greater than that.

I am bound to say to the noble Lord, that, listening to his comments, I wondered a little how much contact he has with the way in which the markets can nowadays manipulate the exchange rates. I remember a conversation I had about 18 months or two years ago with the American managing director in this country of the subsidiary of one of the giant American automobile multinationals. He told me that when his president and hereditary great chief had appeared in London about nine months before, he had given all his senior representatives from all over Europe a pep talk about the need for currency stability and the desirability that of desisting from any propensity they might have to speculate for or against individual currencies. He said that it was in the interests of the multinational in question that there should be greater currency stability and that he expected them to participate in the achievement of that end.

Therefore I asked this gentleman, "Supposing you needed to buy from Switzerland a bank of transfer machines costing, say, £10 million, which were due for starting delivery in 12 months' time and your pundits in the back room told you that, over that period of 12 months, sterling was calculated to depreciate against the franc by 15 per cent. Supposing you then said, 'No, no, no, I listen to the words of my great white chief. I will not pay for these transfer machines until they are delivered in my factory', and so you did not. Then, as a result, you had to pay 15 or more per cent. because your pundits were correct and there had been a depreciation in sterling. Would your great white chief say, 'Thank you' to you for that?" This gentleman had to admit that he did not think he would.

This is the real nature of the problem that exists today. Massive sums are moved at the end of computer terminals. I am bound to say to the noble Lord that I tend to wonder whether all the problems of currency fluctuation are attributable to a loss of confidence abroad in this Government's economic policy. That is not to say that I do not entirely agree with the noble Lord about the desirability, if we could achieve it, of some degree of greater currency stability. Would joining the exchange rate mechanism fulfil that purpose?

I think one has to say that the one thing that can be said with confidence about the exchange rate mechanism is that in every respect it has behaved in the opposite way to that way in which it was expected to behave. When it was established, it was chosen by the Germans very largely in order to give them greater stability vis-à-vis the dollar. It has done no such thing. It was resisted by the central bank in Germany on the grounds that it would lead to imported inflation in Germany. It has done no such thing. It was predicted that it could not last unless there was much greater coherence of economic policies between the participant countries. There has been very little identifiable greater coherence of economic policies between the participant countries. Nevertheless it has survived—and survived remarkably effectively.

Of course we did not join because the then Labour Government were convinced that we should need to devalue the sterling at regular intervals and push it down right to the bottom and out of the bottom of the grid, whereas in fact if we had joined we should have gone right through the top and created enormous strains thereby. Therefore the one thing I think one can say with confidence is that it has never lived up to expectations and I do not see any reason to foresee that it will.

All one can possibly argue is this, and it is a very much more modest claim. There is, it seems to me, no doubt that there may be occasions on which interest rates in this country outside the exchange rate mechanism may be driven up by market pressures regardless of domestic monetary conditions. I must say honestly that I thought that the increase in interest rates last month was desirable because it seemed to me there was considerable evidence of excessive liquidity in the domestic economy. I do not see that there would be the same case for a further upward adjustment in the future. Nevertheless, I believe that one may have to accept that there could be circumstances outside the exchange rate mechanism where market pressures might lead to such an adjustment regardless of domestic conditions, whereas, if we were members of the exchange rate mechanism, attention would be diverted from the sterling-dollar relationship to the sterling-deutsche mark relationship. Hence, at the present time, it is very possible, given the current comparable weakness of the deutsche mark, that the pressures for a rise in domestic interest rates in this country might be less.

But that is a very short-term view point. What one can say if one looks further ahead is that the likelihood—there is no certainty—must be that if we were within the exchange rate mechanism in future, domestic interest rates in this country would require to be higher, not lower, than they would be and probably more fluctuating in order to maintain our place in the exchange rate mechanism than if we were outside it. This would be particularly the case, I suggest, if the dollar bounced off its peg and came hurtling down as I personally, among vast numbers nowadays, suspect may not be far removed.

I can see a certain case to be made for maintaining a tight and relatively dear monetary policy, keeping us in step with the traditions of low inflation and strict monetary control of which the Federal Republic is such a prime example. I do not think that most of those who advocate joining the exchange rate mechanism today espouse it for that purpose. Nevertheless, if they have their way, I believe that is what it would give us. It would not necessarily give us greater currency stability, certainly vis-à-vis the dollar, but it might give us a rather more restrained and more disciplined domestic monetary condition.

8.2 p.m.

Lord Ezra

My Lords, we are indebted to my noble friend Lord Diamond for introducing this debate at the present time. He has set out very clearly, I believe, what are the increasing concerns of people within this country and outside it about the situation of our currency. This is a very appropriate time to be having a look at this situation. We have just heard the views of the noble Lord, Lord Bruce-Gardyne, who is very close to financial circles, on how he sees the situation. I am closer to industrial circles. I should therefore like to talk more from that point of view, and so add to the breadth of the debate.

The fact is that industrialists are getting increasingly concerned about the fluctuating nature of our currency. I happen to be sitting on your Lordships' Select Committee on Overseas Trade, which will be reporting in due course on how we can try to put the trading situation right in regard to manufacturing industry. There is one thread running through the submissions we have so far received and revealing itself as a major factor in our export difficulties. It is the uncertainty of the currency.

While it is argued that the dollar is so strong that other currencies are falling before it, it is also the fact, as my noble friend Lord Diamond pointed out, that in the exchange rate index sterling has fallen substantially. In regard to the major European countries, we have also fallen. It has been argued, although I believe no longer by the Government, that one of the reasons, in addition to the strength of the dollar, why sterling has fallen is the fact that we are a petro-currency. The Government now argue that we are not a petrocurrency because petroleum plays a relatively small part in the economy. Be that as it may, the fact is that other Western countries which have an even larger proportion at stake in oil have not seen their currency suffer as much. I refer particularly to Canada and to Norway. So there must be another factor.

Viscount Trenchard

My Lords, may I ask the noble Lord what is the base year for his statement that sterling has fallen more than European currencies?

Lord Ezra

My Lords, I am referring to the index of currencies and to the period 1980–81. Since that period, we have fallen in regard to these other currencies. The other petroleum producing countries have not shown the same degree of fall. Therefore, there must be a third factor. The strength of the dollar is one; the fact that we produce a large amount of oil is another. The third must surely be the factor to which my noble friend Lord Diamond referred; namely, some increasing lack of confidence in the economic policy of this country as seen from the outside. It is an unfortunate statement to have to make in this noble Chamber, but it does not seem that the two other factors on their own can account for the present situation of sterling.

There are things, it seems to me, that need to be done to correct this situation. What we are trying to do in this debate is to find ways in which we can secure some increased stability in our currency. That is all the more important in view of the fact that many believe—the noble Lord, Lord Bruce-Gardyne, says that he is one of those who believe—that before very long we may see a massive change in the value of the dollar. Surely we should be preparing ourselves for this eventuality instead of just sitting back and letting it happen, with all its dire economic consequences.

The two ways, it seems to me, in which we can do something to moderate the fluctuation in our currency and to prepare for possible massive changes in the value of the dollar are, first, as mentioned earlier in the debate, to join as full members of the EMS. The CBI, which until October 1983 was very dubious about that, has in a recent and very full debate on the subject come to a different conclusion. It is now, by a big majority, in favour of our joining this system. I should like to mention to the House the reasons that the CBI has advanced. I should like to emphasise the industrial aspects of the problem rather than the purely financial.

First, the CBI says that business would benefit from greater freedom to plan ahead since short-term exchange rate volatility would be reduced. This has been emphasised by industrialists who have come before us in the Select Committee on Overseas Trade. A growing part of the United Kingdom's trade, now 44 per cent., is conducted with ERM countries. In other words, this is our major trading area. It is obviously desirable to try to get our currencies in close relationship and in a stable state with one another. There are very serious protectionist possibilities when currencies can change in relation to one another. Conditions now, says the CBI, are as favourable as they are ever likely to be for membership. It states: The United Kingdom's bargaining position within the EEC would be enhanced, which would help us to gain advantages in areas important to business, such as opening up the internal market". I would remind your Lordships that opening up the internal market is one of the major objectives which the Government have set themselves in the phase of the European Community's development. Surely they ought to be looking at all means to achieve that end.

The CBI says that membership would act as a shock-absorber in the event of oil price fluctuations, and would provide the United Kingdom with a "soft landing" as oil production tended to decline. Finally, the CBI says: European political and industrial opinion was in favour of UK membership, making the climate right for joining. Remaining outside would create an unfortunate precedent for a 'two-speed' Europe". On this aspect as well may I remind your Lordships that quite recently it was reported that a meeting had taken place between certain other leading members of the European Community, reviving this idea of a "two-speed" membership. This must be very much against our interests in the United Kingdom.

One can only conclude that business opinion has now moved strongly in favour of our joining the ERM in an endeavour to secure a greater stability of the currency, particularly in relation to our major trading area. The United States may be the largest single national market that we supply, but the aggregate of our trade to the European Community far outweighs that amount of trade. Therefore, the need to look at this particularly seriously at the present time, with the prospect of further massive fluctuations in the value of the dollar, seems to me to be paramount.

There are also wider issues, and I think we ought to reflect for a moment on the reasons why there appears to be this lack of confidence externally in the economic policies in the United Kingdom; and there are some doubts among some of us within the United Kingdom. The doubt that we principally feel, and have voiced from these Benches on many occasions, is that we detect on the part of the Government a certain lack of interest in what one might describe as the physical economy (the physical economy being the infrastructure) which a recent report by the National Economic Development Organisation has shown is in a relatively poor state of repair—the Government have still to answer that report—and the state of manufacturing industry, the weakness of which is revealed by the fact that for the past two years, and for the first time since the Industrial Revolution, we have run into major external deficits on our overseas trading in manufactured goods. In 1984 the deficit was very nearly £4 billion. This is an indication of the weakness of the physical economy of Britain, both in its infrastructure and in its manufacturing capability.

I would sum up by saying that this question of the situation in which sterling finds itself goes deeper than the day-to-day value of the currency. It is in very large measure a reflection of the confidence expressed in our economy, as President Reagan was not slow to point out after the Prime Minister's visit to his country. We need to try to correct that by, on the one hand, linking ourselves more closely with the currency grouping established within the European Community, in which we do the bulk of our overseas trade, and by, on the other hand, paying very much more attention to the physical economy of our country.

8.14 p.m.

Lord Kagan

My Lords, I rise with diffidence after listening to such important representatives of industry and finance. Surely the value of a currency is the thermometer of a nation's wellbeing. The British economy—and I speak from the smaller end of the economy: from Yorkshire—has been in the intensive care unit for over 20 years. The patient has been kept alive by spending the earnings of the past and latterly by selling some of its capital assets. As the noble Lord, Lord Ezra, pointed out, the fortuitous bonanza of oil was the infusion which gave the pound sterling its tubercular rosy glow. The underlying malaise is still there and is accelerating.

In order to see a change, to see a light at the end of the tunnel, two conditions will have to be met. One is acceptance of wages demonstrably related to and dependent on productivity. At the moment this would mean a considerable decrease unless there is a dramatic increase in productivity and efficiency, which is hardly likely to happen suddenly. The second condition is a financial climate which will make investment attractive and safe.

At the present moment wages are being adjusted by the fall in the pound through a floating exchange rate. The second condition is being facilitated by a steady rise in the FT Index on the Stock Exchange, based on, and a function of, the productivity which is being achieved. That is what we are seeing. In January 1981 the pound was worth 2.40 dollars. The Stock Exchange FT Index at that time was 459. In January 1985 the pound had slipped to 1.12 dollars but the FT Index had risen to 977. The pound is now approaching parity with the dollar; the index is nudging the 1,000 mark. Therefore the pound is less than half its value; the FT Index has more than doubled. It is a decrease on average of one-half of 1 per cent. per week in the effective value of the pound and an increase of one-half of 1 per cent. per week in the effective value of shares.

I do not think it could have been done in any other way, because since the war the dilemma of successive British Governments has been that to do what is economically right would prove politically suicidal, and to do what is politically right would prove economically disastrous. Therefore there is no mystery. It is not the currency which is unstable; it is the patient which is unstable. If it is not unstable it is declining, as the noble Earl, Lord Stockton, said, very graciously.

Is there a way out? Is there a light at the end of the tunnel? Britain, it was said, is a block of coal immersed in a lake of oil. Its knowhow and its research have led the world for generations. Japan, by contrast, has no indigenous energy resources. It lagged behind in technology and in science. Its people copied, bought, or borrowed our knowhow. Yet they have achieved surpluses bigger than our deficits, and they have achieved rising living standards and also strong currencies. We did the opposite. What is the reason? It lies purely and simply in industrial relations. While we are squandering our national strength on confrontation between labour and management, they have no adversarial industrial relations. If in the past the Japanese have helped themselves to our knowhow and subsequently to our markets, should we not perhaps now return the compliment and study and emulate their ability to work together in industry in co-operation and harmony?

8.20 p.m.

Viscount Trenchard

My Lords, I apologise for intervening at little notice in this debate. However, having listened to the speeches with great interest I felt that there was perhaps room for another industrialist, as opposed to a financier, to make a point or two. Let me begin by saying that, having spent my life in industry trading in many countries and between many countries, I could not disagree with the pleas of the CBI, to which the noble Lord, Lord Ezra, has referred, about the desirability of having greater stability. That is real and it becomes very important when we have the type of fluctuations in the exchange rate that we have had since 1975. Since that time we have had the fantastic rise in oil prices, the scare as to whether there would be enough energy for the civilised world, and then the situation where there was plenty of energy, and so it is not surprising that we have had these very great and unusual fluctuations.

In such situations, it is not unusual for businessmen—and I have certainly been guilty myself—to say, "For goodness's sake! let's try and do anything", including, "Let's join the EMS". I am not qualified to pronounce on what I believe to be the marginal effects of joining the EMS at any particular time. There is the idea that the joining of the club, or the snake (as it used to called) is a panacea. However, the CBI should face up to the fact that that is simply not a realistic way, in present conditions, in which to achieve absolute stability.

Lord Ezra

I should just like to point out to the noble Viscount that I do not believe that the CBI ever claimed that it would be a panacea. In their recent debate they concluded that, on balance, they thought that the time was now ripe to join.

Viscount Trenchard

My Lords, I stand corrected. Indeed, the thrust of my argumentation and, I am sure, their knowledge is that it can only, perhaps, be a help in the right direction. When there is a great need and a great desire one is inclined to say, "Let's do this" or, "Let's do that". One must take with a grain of salt the degree of benefit that one is likely to obtain from that particular course of action which, as I understand it, is really the only positive line of action that has been suggested to us today. I shall return in a moment to the other factors which have been suggested as responsible for major fluctuation.

I should like to endorse what my noble friend Lord Bruce-Gardyne has said; namely, that we have underestimated, or that everybody has estimated incorrectly, the exchange rate. I believe that perhaps the biggest underestimated factor has been the oil and the energy factor—in both directions: both when the pound went up and when it has gone down along with other currencies.

The noble Lord, Lord Diamond, linked the Government's policies entirely to monetarism. The Government's policies are aimed at getting an atmosphere for more competitive industry and they are wide and varied. However, the noble Lord suggested that it was Government policies, linked particularly with monetarism and unemployment, which he suggested resulted from them—something which I would dispute on any other occasion when we had more time—which had had the major effect on the pound. I do not think that the noble Lord said it, but the idea that, within the margins of possibility, a small increase in Government expenditure as regards the unemployment situation would make foreign financiers jump with joy and invest in the pound is to me really ludicrous.

I had a great deal of common ground with the noble Lord, Lord Kagan, when he said that our problem has been in the real economy for, I think, 20 years—I would say 30 years, if anything—and we simply have not been competitive. I have said on so many occasions in this House—and I shall not dwell on it for long tonight—that enormous world expansion has masked our uncompetitiveness. A combination of Government policies; fluctuation in the exchange rate caused mainly by the oil crisis when the pound went right up to abnormal levels; and the world depression, which brought the huge world expansion very abruptly to a stop, produced a degree of competitive urge on the British real economy which did not entirely stand up to it. Indeed, we all regret the huge unemployment. I, for one, regret that some of our manufacturing industry is no longer with us because I believe that today it could again be viable.

However, having said that, I do not believe that anything less than the pressures arising from those three factors could have so quickly changed British attitudes. I am referring to British productivity trends, which have been astonishingly good in the last two years, albeit from a very low level. There is the beginning of a more healthy trend in the export/import relationship, which we have seen confirmed in January. I believe that before long we shall see our share of the world market figures at least stabilise. They are hard to read because they are measured in constant dollars and, once again because of the exchange rate, the real effect of trying to show shares of world markets in constant dollars is almost impossible. In my view that means that their current reading and the reporting that our shares are now down to 7 per cent. is an exaggeration. If you consider the exchange rate you will realise why.

Lord Diamond

My Lords, may I interrupt the noble Viscount? The noble Viscount has said that the main cause of the instability of the currency is not lack of confidence in British economic policy but is entirely due to the movement of oil—the increase in price and then the flood of oil. How does the noble Viscount reconcile that with these two facts: first, with the fact that sterling has fallen every month since 1980 to less than half its then rate; and secondly, with the fact that oil production has increased at the same time, month by month, and that in January, when sterling was undergoing all its worst variations and knocking on the floor, the production of oil, so far as the Exchequer was concerned, was at its greatest?

Viscount Trenchard

My Lords, I did not say—and I have not finished my remarks—that oil was the entire reason. I was also talking about a much longer time span that the last 12 months. My noble friend Lord Bruce-Gardyne has already referred to the fall of other currencies against the dollar. It entirely depends upon which point you wish to take as your baseline. In my thoughts on oil I included the underestimation of the effect that oil had on the strengthening of sterling from our very weak competitive position in the real economy in the late 1970s. I would only add that the oil price, and the trend of the oil price, is the important factor that should be drawn to your Lordships' attention.

It has been the feeling in recent months that it is the weakness of the oil price and the belief that the British economy is too dependent on oil which has been responsible for any extra weakening of the sterling exchange rate. I believe that by the time the international financial fraternity has time to realise that the foundation of real competitive improvement—which has nowhere near gone far enough yet—has been laid, bearing in mind that with our standard of living as it is at the moment we are a relatively low wage and people cost country, then with improving competitiveness and improving productivity the international financial fraternity will, before long, twig that we are not just an oil currency. Any extra weakening which has occurred in sterling in recent months would be attributed, in nearly all the international financiers' minds who have speculated against the pound, to the fact that they wondered whether the British economy was still too weak to recover, and to the feeling that if the oil price was going down, since it is an oil economy, perhaps they had better sell sterling.

They are wrong. They will find they are wrong. The financial markets are slow reactors to the real economy. They have proved to be so in the reverse direction. They are slow reactors now. I believe that the answer to greater stability in the exchange rate will come when—and only when—our economy has continued to improve, encouraged by present Government policies, and it is seen widely that we are on an even keel. At that point we can expect less fluctuation for Britain specifically, whether we are within or without the EMS. If the energy pattern goes through the same fantastic changes which have occurred since 1975–76, then also whether we are within the EMS or without it there will regrettably be fluctuations, and severe ones, much as we would wish that they would not exist.

8.32 p.m.

Lord Barnett

My Lords, I join in the congratulations to the noble Lord, Lord Diamond, for initiating this important debate. I found his views somewhat unusually extremist in seeking to blame the Government for almost everything under the sun, including what has happened to the exchange rate. I was rather surprised. I am sure his leader would not like it. I wish that I could agree with the noble Viscount, Lord Trenchard, in the qualified, guarded optimism he expressed about the state of British industry. While you can do a lot with statistics, there is little sign that British industry is proving to be as competitive as he seemed to imply.

It will be known to your Lordships that on the question of the exchange rate mechanism of the European Monetary System I take a somewhat different view from that of my own side of your Lordships' House. But this is a relaxed place, and I feel I can readily have it accepted that I am personally in favour of our joining the exchange rate mechanism. I always have been, and remain so. But may I equally say that, like the noble Viscount, Lord Trenchard, I do not believe that it will do all that has been said for it by the noble Lord, Lord Diamond, or the noble Lord, Lord Ezra, in creating the degree of stability in our currency which everybody would like to see. Whichever side of the argument we are on, I do not think anybody would disgree with the need, particularly in industry, for greater stability in the currency.

I think it was the noble Lord, Lord Ezra, who referred to President Reagan. I am bound to say on this question of the European Monetary System that I have spoken to a number of people who were previously opposed to our entry and who are now beginning to feel not quite so opposed to it. The reasons are clear. What President Reagan said—if somewhat discourteously just after the Prime Minister had left his office—was that Europe must get its own house in order. I think he was quite right: Europe must get its own house in order. It must surely have been seen that we have little chance of doing it, as a nation, on our own. We cannot stop the speculation against the pound (with a strong dollar) on our own as a country.

I think it was the noble Lord, Lord Bruce-Gardyne, who said that within the European Monetary System, if we were in it, there would still be times when we would need to have high exchange rates. I would not dispute that, although he seemed to imply, or say specifically, that it would be a permanent question of having higher interest rates within the exchange rate mechanism, and I would not necessarily agree with him on that. I would say that there are better prospects of stability within the EMS than without it. That is the simple point I would make. It would seem to me that the crisis that there has been over our currency and over other currencies while we have been outside the EMS has given this country the worst of all worlds. We have been deprived of stability, and have still had to have very high interest rates. In that sense we have had the worst of all worlds; whereas inside the EMS—and I thought the noble Lord, Lord Bruce-Gardyne, was virtually accepting this—there would be less hysteria about the dollar rate than there is at the present time. I see the noble Lord nodding in agreement.

As for the fear of those who in the past have argued that it would be a constraint on our making our own independent economic and financial decisions, that argument must surely have been exploded by the crisis we have been seeing. We have had very little real independence in the control of our own currency while outside the EMS. Unity in many fields is the best hope for stability, and that particularly applies in the case of currency. That stability would be better obtained within the EMS than outside it, although I agree with the noble Viscount, Lord Trenchard, that it is by no means a panacea. There are many other problems we face, and we would still have the problem of a strong dollar.

I make it clear to the noble Earl the Minister that I do not blame the Chancellor and the Government for the strength of the dollar against the pound and other currencies. I am not a vengeful kind of man. I shall resist the temptation to reply in kind to what the present Chancellor said in 1976 (although I remember it well) when the pound was $1.55. I am willing to go along with what the noble Lord, Lord Bruce-Gardyne, said: that the fact that it is $1.06 to the pound is not a sign of a lack of confidence in Her Majesty's Government. On the other hand, I am sure he will recall, and equally agree, that when the Prime Minister said in 1981, when it was $2.40, that this showed the world's confidence in the way her Government were managing the economy, that was equal nonsense. I see the noble Lord smiling, but I shall not tell the Prime Minister.

In any case, the question about the stability of the currency is not about the dollar. We are talking about the stability of the currency. I note what the noble Lord, Lord Bruce-Gardyne, said about his and many other experts' view that the dollar is going to plummet very soon. It makes me feel that I should go out tomorrow and buy some dollars, because it is rare that they have been right in the past, although I suppose on the law of averages they must be right at some time. But I am not blaming the Government—at least, not tonight—for this particular problem.

What we need to do, as many speakers in this debate have said, is to look at the pound not against the dollar but against a basket of currencies, against an index. If we look at an index which excludes the dollar—because, after all, the dollar makes up 25 per cent. of the usual index that is quoted as a basket of currencies —since 1979 there has been a decline of about 18 per cent. against that basket, as opposed to 47.5 per cent. against the dollar.

That is a very different situation; but, of course, it does not make a media headline to talk about an index. You need to talk about the dollar—that is a nice media headline. I regret it, and I think it is wrong to look at it in that way, even if it will deprive the Prime Minister in the future, when the pound rises against the dollar, of claiming some great new-found confidence in the pound and in her Government's economic policies.

Underlying the Question on the Order Paper is the plain fact that we can only ensure reasonable stability of the currency in relation to the United Kingdom's performance relative to our competitor countries. In that I thought that my noble friend Lord Kagan got it absolutely right. Given our poor performance, not just since 1979 but under successive Governments, it is not surprising that the value of the pound has generally declined against most currencies. It was bound to do so. But two main questions need to be answered. First, what is the Chancellor doing, and what should he do, in the short-term in the face of the strength of the dollar? Secondly, what is the Chancellor doing, and what should he do, in the long-term to ensure what the Question on the Order paper asks: to ensure reasonable stability of the currency", which, as we have all agreed, is clearly in all our interests?

On the first question, about the short term, we have been told by the Government that the actions that they have taken are simply to ensure that the Government's strategy will keep on course. That is what we have been told, and I have no doubt that that is what the noble Earl will tell us again this evening. However, was it really the intention of that strategy to have high interest rates and no tax cuts, or was it to have low interest rates and large tax cuts?

The Earl of Gowrie

My Lords, when we can afford them.

Lord Barnett

My Lords, the noble Earl says, "when we can afford them". It is interesting to note that the noble Earl feels that we cannot now afford lower interest rates and we cannot afford tax cuts. I am sure that the Chancellor will probably agree with the noble Earl—at least, we assume he will— although he would not want it known that his fellow economic Cabinet Minister has just told us that we cannot afford them, because in a couple of weeks we may get them.

The Earl of Gowrie

My Lords, then we can afford them.

Lord Barnett

My Lords, it is amazing how Government economic policies can change by the minute in this country by the whispered utterance of the noble Earl. However, we shall wait for 19th March for that. We were told by the Prime Minister (or at least, as the noble Lord, Lord Diamond, said, in statements being issued from No. 10) that it did not matter at the time if the pound dropped, that the Government were quite indifferent to that. They said that that was irrelevant and that what mattered was to keep the economic strategy on course, whether or not we could afford the tax cuts. However, within days of that statement someone got at the Prime Minister and we had intervention in three ham-fisted instalments, thus increasing interest rates to levels which are obviously damaging to industrial confidence, as I am sure that the noble Viscount, Lord Trenchard, would accept.

Not only do we now have instability of the currency: we have instability of interest rates. We have just about the worst of all worlds. Is that keeping the strategy on course? Is that what the noble Earl is telling us—that this is the way in which to keep the strategy on course? We have been told by the Prime Minister that there are three reasons for the weakness of the pound as against the dollar. First, there is the strength of the dollar. I entirely accept that. I accept that at some time it will probably fall, although that may well be rather further away than many, including the so-called experts, have argued. There are billions of dollars floating around the world with no home to go to that they fancy (other than that of the dollar), so the odds are that they will stay high rather longer than most of the experts would argue.

I believe that it was the noble Lord, Lord Bruce-Gardyne, who told us about the big white chief of an American company and what he would do in the case of some of his minions who had to buy $10 million worth of goods from abroad in foreign currency—whether he would wait until he had to pay for them. I would have told that man to cover the cost now because I do not know what the currency will be in nine or 12 months' time, and that I am not in the business of gambling but in the business of buying machinery at the price which I have agreed. That is what I would have said, but, then, I am not the big white chief and friend of the noble Lord.

However, the other reason given by the Prime Minister for the weakness of the currency is that the price of oil has fallen. Not only would that be a very odd reason for the case which the Prime Minister has made, but in practice it was always obvious that if the dollar rose the price of oil would fall. There is nothing exceptional about that; it is quite understandable that it was bound to fall. At one time we were told by some that the coal strike was the problem, but, as we have seen, the ending of the strike has of itself not helped the currency at all. I venture to suggest that it may well be for the reasons that my noble friend Lord Kagan mentioned, that there are those in the outside world who suspect that the underlying concern should be about the way in which this Government are managing their industrial relations problems. That may well he more the reason than an ending of the coal strike, which most of us would welcome.

However, none of the reasons given by the Prime Minister surely required the kind of panic action of the massive increase in interest rates that the Government introduced, because, as I have said—and I think that most noble Lords would agree—there is nothing that we alone can do about the rate of the dollar. There is little that we alone can do about the price of oil, although it is to be expected that the price will come down if the dollar goes up.

It may be that the noble Earl differs from his Chancellor on this as well, but I thought that the Government were strong believers in the market economy—or are they? Do they now think, as the Prime Minister seemed to imply—and perhaps the noble Earl will tell us—that the market has got it wrong, that the market was quite wrong to bring the pound down to $1.6, or whatever? Or do the Government remain believers? If that is the case, why are they fighting the present rate against the dollar with irrational and damaging action on interest rates? What is it that they are doing to keep their strategy on course?

We have also been told that the Chancellor thinks that outside commentators fear that the Government are weakening in their resolve on inflation. As a critic of the Government's economic policy, I am bound to say that I think they will keep inflation at around 5 or 6 per cent. because, like the management of an economy, if you want to keep just one economic ball in the air you can do so if you do not mind what else happens in the economy. Having got one thing right, even at the expense of massive unemployment and everything else, I think that they will keep down inflation.

Therefore, why did the outside world gain the impression that the Chancellor was weakening in his resolve on inflation? It could not be something that anyone else said; it could only be something that the Chancellor himself said. He told the world that he would cut taxation by £1.5 billion. No one else said that; he said it, and that made the City and the markets outside fear that the Chancellor was weakening in his resolve on inflation. Perhaps the noble Earl can tell us this. If the Government believe that the markets have it wrong and that some time during 1985–86 the dollar will plummet and the pound will become stronger, as was said by his noble friend Lord Bruce-Gardyne, will that not mean that the Chancellor will not only not be able to reduce taxes but will have to increase them: that instead of the extra £2 billion of additional revenue from a lower pound and therefore extra oil revenue he will have to increase taxes? Is that not the situation? Or what is it that the noble Earl and the Chancellor are assuming will happen to the dollar during the course of the next year?

Lord Bruce-Gardyne

My Lords, I am most grateful to the noble Lord for giving way. Is the noble Lord really sure that the signal which concerned the markets in the autumn was the revelation (which, as he knows very well, is in any case statutorily imposed upon the Chancellor) of the so-called fiscal adjustment in the Autumn Statement rather than the indications, which had been persisting for some time and which seemed to persist until early into the new year, that the Government's intention was that if sterling steadied at all they would be determined to bring down interest rates and that if sterling slid they were determined not to allow them to rise? Was that not more the message which the market did not like?

Lord Barnett

My Lords, unlike the noble Lord, who is usually very certain of most matters, I am not so certain about this. I was quoting the Prime Minister having indicated that the markets feared that the Government were weakening in their resolve on inflation. They knew about the fiscal adjustment—of course they did; that was available from the moment the Chancellor published his public expenditure figures, and everyone knew that. However, despite knowing the fiscal adjustment, as he and I know it like old friends, there is a very big difference between that and the Chancellor saying that he has it in mind to reduce taxes by £1.5 billion. That is a very different situation. That is not only my view; it was the view of the Prime Minister, that there was this weakening of resolve.

However, I should like the noble Earl to tell us tonight what the Government propose to do in the short term to deal with the currency instability—whether they remain indifferent or whether, if necessary, they would prefer a 20 per cent. interest rate to dollar/pound parity. What exactly is the Government's position? If the pound strengthens against the dollar—not against other currencies necessarily—what would the Chancellor be compelled to do in his Budget now? I put that question rhetorically because I perfectly well understand that even if the noble Earl knew what was in the Budget he is not going to tell us tonight although it might be very helpful if he could: it might even be helpful to the Chancellor—perhaps the Chancellor might be able to change it, but I am sure he will get it wrong anyway.

To turn to the second question that I posed, which is what do the Government propose to do in the longer term, we have been told ad nauseam that the ship is on course, the strategy has not changed, and so on. If that is true and if the ship is on a good course, why on earth are the Government so worried, on their own analysis, about an irrational and temporary strengthening of the dollar against the pound and other currencies, rather than looking at the pound, as I have indicated, against a basket of other currencies? Why intervene in a way that will indeed have an effect even on the Government's own shambles of an economic strategy?

As I have said, I do not agree with that strategy, which after six years still leaves us with very high unemployment, with no prospect of that coming down and with industrial growth starting to rise but, as the noble Viscount, Lord Trenchard, said, starting from a pretty low base. I, for one, do not pretend that it was very high even in 1979. I would not suggest that for a moment; but the bungling in recent weeks has left the Government's economic policies in an absolute shambles.

The fact is that in the short and long terms, whatever economic strategy this Government or any other Government have in this country, we should surely stop talking about a pound/dollar relationship and talk of an index. And if we can find a graphic way of referring to that so that the media will find a phrase they like, rather than just looking at the dollar all the time, I think it would be helpful to the running of our economy. But in any event, if the only way we could, even temporarily, prevent a further fall in the pound against the dollar—not necessarily against other currencies—is yet further damaging increases in interest rates, then it is surely better to let it find its own level. I do not know whether the noble Lord, Lord Bruce-Gardyne, would agree but he seemed to be saying—very gently perhaps—that he would not fancy any further increase in interest rates. That is what I thought he was saying: he is neither nodding nor shaking his head, so I presume he agrees. That is what he said.

However, I think it is fair to say that any further increase in interest rates from the present very high level, simply to prevent the pound temporarily—and I accept that it would be temporary—falling against a phenomenally high dollar would be quite wrong. In the longer term, it seems to me that only a different strategy that produced a better industrial performance could, in the words of the Question on the Order Paper, ensure reasonable stability of the currency".

8.53 p.m.

The Chancellor of the Duchy of Lancaster and Minister for the Arts (The Earl of Gowrie)

My Lords, I welcome, in more than conventional terms, this short debate; it has been a very good one. I am relieved that it has been rather shorter than the televised marathon when we first raised these issues in January. I note with interest that the noble Lord, Lord Diamond, disagrees in most of his analysis with his right honourable friend and Leader, Dr. Owen; and I note that the noble Lord, Lord Barnett, disagrees with his right honourable friend and Leader, Mr. Kinnock. This suggests—

Lord Diamond

My Lords—

The Earl of Gowrie

My Lords, may I just make the point because I am just about to concede something which the noble Lord may be seeking to ask me to concede. These disagreements suggest to me that there is no such thing as a truth written in tablets of stone in parties opposite, any more than there is in respect of my party, on currency issues or in respect, for example, of agreements between President Reagan and Mr. Volcker. The air is full of noises where views on the right levels of currencies are concerned.

Lord Diamond

My Lords, I am grateful to the noble Earl for giving way. I only rise to say that in each of his last three speeches he has made to me the same statement, which I have never been able to follow, that I am out of step with my leader. I know of no instance in which that is the case. In something which I do know, the Tory Party has been requested to make, as a political point, on every possible occasion, as indeed has the Labour Party: we understand that very well. But I am unaware of any single instance on the past three occasions on which the noble Earl has been pleased to make this comment, of there having been any difference at all. If there were, I would be grateful to him for pointing it out.

The Earl of Gowrie

My Lords, I am one of those who has been urging the Tory Party to study the pronouncements of Dr. Owen most carefully, because they are extremely sensible on most issues and also because they seem to have a very close correspondence with most of the utterances of the Prime Minister. I am delighted to take this up in a general economic debate.

I am glad therefore to have the opportunity to say a few brief words which may clear up some misconceptions which have been raised by speakers, in spite of their distinction and experience—and we have had no fewer than three former economic Ministers tonight. That is one of the reasons why I have enjoyed the debate so much.

The noble Lord, Lord Diamond, has asked what steps the Government are taking to restore reasonable stability to the currency, and I propose to concentrate mainly on that. Let us consider four central issues. There is the issue of what has actually been happening to currencies recently; there is the issue of the term "reasonable stability"; there is the issue as to why instability arises; and the issue of what the Government could or should be doing to tackle this and its causes. Then there is the issue of the case for full United Kingdom membership of the EMS.

What has been happening to currencies recently? We would do well to remind ourselves of a few very basic facts at the outset, and I want to start with what seems to me to be the most important point. Recent development in this story are all to do with the value of the dollar. This was the clear agreement at the Group of Five meeting in Washington in January. Even though it fell back last week following concerted invervention, the dollar is still higher than when the Group of Five met. It is 9 per cent. up against the Swiss franc; it is 8 per cent. up against the deutschemark; and it is 6 per cent. up against sterling. Whether one calls this a crisis certainly is not an issue for this particular debate. But even if one calls it a crisis it certainly is not a crisis of the falling franc, yen, pound or lira, but of the value—perhaps the over-value—of the dollar.

If the noble Lord, Lord Diamond, is to be believed, the markets are giving a "thumbs-down" to the Swiss and German economies as well as to our own. I have to say, with all the respect and affection that I bear for him, that the strictures in the first part of the noble Lord's speech are as ludicrous as they are irresponsible; and I congratulate my noble friend Lord Bruce-Gardyne for clean-bowling the noble Lord, as it seemed to me, on that central issue—because the record shows that the bilateral exchange rates between most currencies other than the dollar have in fact remained rather stable.

There has not been much fuss about the deutschemark/yen exchange rate or about the exchange rate between the Swiss and French francs. At the end of last month sterling fell against other currencies as well as against the dollar. However, that fall was shortlived, and since last month's low, the sterling index has risen 1 per cent. against other currencies overall and considerably more against the deutschemark. There has also been for us to consider a great deal of dealing in currencies across the exchanges, often described—not always entirely helpfully—as speculation.

What is "reasonable stability" of a currency? Perhaps we all yearn for a world of total stability, both in exchange rates and in domestic prices. Some of us—and I am sure that includes many of your Lordships—would rather like to see a restoration of the Bretton Woods system of fixed exchange rates, and certainly it is tempting to try to move in that direction. But I must say that I see no prospect of this desirable system being restored. The will is not there in the contemporary world and, even if it were there it seems to me rather unlikely that the means, the expensive means, could be found to give effect to it. So, if we are realistic, we have to accept that we shall continue to live in a world where floating and fluctuating exchange rates will predominate and I believe that this will remain the case, even if we and others join the EMS in due course.

Nor does it seem to me that such a world, while it may be less desirable than the Bretton Woods world, is as intrinsically bad as some critics would have us believe. For instance, fixed exchange rates do not always, or automatically, bring about the wider economic stability that one instinctively—perhaps through yearning—associates with them. Anyone who recalls the traumas of our devaluation in 1967—and the noble Lords, Lord Diamond and Lord Barnett, will surely do that most vividly—will know that fixed exchange rates can both appear as an overwhelming obstacle to a Government's plans while they are fixed, and when they are changed can simultaneously, as it were, trigger off an earthquake in an economy.

So it seems to me that, in principle, the market system is the best system for allocating resources. Changes in prices are fundamental to that system, to ensure that producers supply what is demanded at the lowest overall cost. In economic terms, the exchange rate is just another price, although it is rather a unique and certainly an important one. There are, therefore, powerful arguments in favour of allowing it to vary as we should allow other prices to vary.

It is sad to see that the Labour Party is still persisting in the belief that the state can allocate resources more efficiently than the market. Mr. Hattersley's plans to withdraw fiscal privileges from institutions holding more of their portfolios overseas than in 1979 represents, it seems to me, and I imagine to that former Chancellor of the Duchy of Lancaster, the noble Lord, Lord Lever, an irresponsible threat to the overseas "nest egg", which our oil revenues have helped us to create against the day when oil, itself an overseas as well as an under-sea asset, so to say, plays a less important part in our economy.

Surely the right approach is to allow the market, as now, to channel funds freely wherever the return is highest. If this seems a little bit believing, theological perhaps, to your Lordships, may I remind the House that in the market there is an up-side as well as a down-side to the present sterling/dollar relationships, as our exporters know to their benefit and to the benefit of those whom they employ. I know that many of the industrialists, to whom the noble Lord, Lord Ezra, is indeed close, will acknowledge that at the present time.

It is a fact of life that economies are always changing and so are the relationships between economies. Freezing one part of the system, such as the exchange rate, cannot halt that process. The underlying variability and volatility in the economy concerned will not go away, but will be shifted elsewhere. If you fix exchange rates, the burden of variation and adjustment will typically fall on interest rates instead. It is not obvious that this result is better than if both exchange and interest rates are allowed to move freely, and in my experience, when you allow them to move freely, they readjust fairly rapidly—

Lord Barnett

My Lords, the noble Earl is giving us a very interesting clarification of the Government's policies in these few regards. Therefore, is he saying that the exchange rate and interest rates are not something that the Government intend to have anything to do with but they will leave them to the markets?

The Earl of Gowrie

My Lords, I think the noble Lord will be happier about my clarification of the Government's position if he lets me come to an end of it, because I was coming to the point that he has mentioned. What I am saying is that there are up-sides as well as down-sides, in the jargon of the system that we have at the moment. I do not think we should forget that business worldwide has now had rather a long time—I have not checked exactly, but from recall it is about a decade—in which to adjust to flexible exchange rates. The experts will tell us that sophisticated forward markets, currency options and the like now provide a swiftly growing range of increasingly economical hedges against possible currency fluctuations.

I do not know whether some of your Lordships have noted as I have—and I commend it to my noble friend Lord Trenchard, as well as to the noble Lord, Lord Ezra—a recent study published in the Bank of England's Quarterly Bulletin in September last year. That study suggests that exchange rate volatility has, in fact, not had significant damaging effects on the United Kingdom's trade. This may help—

Lord Ezra

My Lords, that may well be the view of the Bank of England. All I can say is that the view of very many industrialists, with whom I have had recent contact both in your Lordships' House and elsewhere, is much to the contrary. They find it very hazardous to operate in markets where they will be selling ahead for two or three years, not really knowing how exchange rates might operate in that period.

The Earl of Gowrie

My Lords, I am not at all surprised, if I may say so respectfully, at this divergence of view, if indeed it is a divergence of view. If you ask any group of people who have just been through a rather battering experience, where there has been a considerable degree of fluctuation, whether they like it, they are bound to say that they do not like it. I do not blame them. Nor would I. What the Bank of England was doing was showing that over a period of time of these fluctuating exchange rates the outturn for British trade has not been as adverse as is suggested, and indeed has not been adverse because trade has been growing. What I was also saying was that the dear old and much maligned market is now throwing up all sorts of mechanisms, admittedly at some cost, by which people can hedge against currency changes in terms of their trading activities. I am not saying in any sort of Panglossian way that the more divergence or variability in exchange rates the better. I am saying that there is an up-side to the down-side of the present international volatility.

Divergent trends in exchange rates often warn that domestic economic policies are wrong and may need correction. Big random day-to-day variations in exchange rates of themselves inevitably create uncertainty and raise the costs of doing international business. So of course it may be worth trying—this may help the noble Lord, Lord Barnett, in his query—to reduce them, though obviously the likely benefits of trying to reduce them must exceed the costs of doing so. As anyone who served in the 1967 Labour Government will know, the costs of doing so are very considerable indeed.

Let me therefore accept with my noble friend Lord Trenchard for the moment that, other things being equal, of course less currency instability is desirable. What therefore can sensibly be done about it and what are this and other Governments doing? There are no simple answers to the question because everything hinges on why the instability arises. There are four broad reasons for this, each of which I shall discuss. I apologise to your Lordships if the lateness of the hour means that I must discuss them very briefly.

The first cause, as I have already said, is that domestic policies of one or more countries may be out of kilter, for example, leading to large and widening differences in inflation rates. Along with most reputable observers and authorities around the world, the Government believe that the dollar strength reflects weaknesses in United States' internal policy, in particular the large and growing budget deficit. We made our views clear to the authorities there repeatedly and have urged others to do so.

This view has for some time been publicly endorsed in the commitment to pursue convergence in domestic policies made at the Williamsburg Summit in 1983. My right honourable friend the Prime Minister repeated the message only the other day when she was in Washington. As she said in another place on her return (and this was repeated in a Statement in our Official Report at col. 854): In our discussion of economic issues I explained the concern in Europe at the continued rise of the US dollar against other currencies. I found this concern widely shared within the United States Administration, not least because of the adverse effect on their own agricultural and manufacturing industries, but it was recognised that no easy remedy existed. The President and I agreed that the best contribution the United States could make … lay in a reduction in their budget deficit. The President has put specific proposals to Congress to this end".—[Official Report, 26/2/85; col. 855.] I am sure that noble Lords speaking in this debate who take a great interest in such matters will have noted that Mr. Paul Volcker for his part has given a further powerful signal of his concern in his recent testimony to Congress.

I referred briefly earlier to sterling's temporary weakness at the beginning of the year. Part—and I stress it is only a part—of that problem was doubts about the United Kingdom's domestic economic policies. There I agree with the noble Lord, Lord Ezra. There were fears that our priorities were changing away from fighting inflation to reducing unemployment by expansionary and inflationary changes in public spending, changes of the very kind that the noble Lord, Lord Ezra, and his party are urging upon us.

These doubts fuelled the sharp upward pressures on interest rates in January, pressures which the Government felt it right to endorse in order to underline that our priorities have not shifted. Since that time sterling has in fact reacted; it has been stronger and more stable, as has been borne out by the figures that I quoted earlier. The key issue in both cases—this experience is also borne out with the experience of France a year or so ago—is that individual countries should pursue sensible policies and not give markets legitimate grounds for doubt that they are on course.

It is worth asking whether United Kingdom membership of the exchange rate mechanism of the EMS would have helped. No one in their right mind surely could believe that it would make any material difference to United States policy. The issue there is not how other countries organise their currencies but the United States attitude to its deficit and the capacity of it to attract money to fuel that deficit. Our being in the EMS would not have had any material effect on the problem or on the American determination to tackle it. Nor probably would EMS membership have helped dispel any doubts that there may have been about British domestic policies in recent months.

The EMS provides its own discipline by requiring members to stick to parity limits. That commitment typically requires substantial and prompt interest rate changes or sterner measures still such as tax increases or spending cuts. Indeed full EMS membership could well increase the pressure for such moves when a member's policies on exchange rates are open to sustained doubts. My noble friend Lord Bruce-Gardyne mentioned that point.

One must therefore ask whether in such circumstances—that is to say, dollar strength or doubts about our own sureness of purpose—intervention could be the answer. Intervention—by which I mean the buying or selling of currency against the tide of the market—is unlikely to change the trend itself. Unless the circumstances are right, it offers currency speculators a one-way option at the expense of governments and can inflict large losses on the authorities.

This was the clear experience of the Labour Government in 1977 when the right honourable gentlemen, Messrs. Healey and Barnett (as the noble Lord then was) pegged the pound/dollar parity and had to give up after a few months, having intervened on a very large scale in an attempt to beat the speculators and keep the pound down. I am not blaming them for their attempt; I am saying that we—unlike the Labour Party nowadays—tend to learn from our own and from others' mistakes. It can only work if the sums at the disposal of the interveners are really large and if there are no deep-seated trends which the action seeks to oppose.

The second cause of' instability is major changes in the external environment. As all speakers have said, the United Kingdom experienced this strikingly both with the oil crisis in 1979–80 and the weakening of OPEC and oil prices in recent months. The third and fourth causes of instability are the so-called speculative movements of hot money; and the propensity of markets in the short term—and I stress that—to overreact or overdo things when adjusting to changing circumstances. Such processes depend on market operators' belief that they can buy or sell a currency over a short period with reasonable chance of success and relatively little likelihood of painful loss. To some extent in markets, perceptions of the balance of such rewards and risks feed on themselves. The more that process of speculation develops, the more new participants or extra funds will be drawn into play and the greater the risk of disorderly markets.

May I say to the noble Lord, Lord Barnett, that believing in the overall efficacy over time of market judgments is not the same as believing that each individual market reaction is well conceived. Were that the case, there would be no such thing as commodity or even stock broking, for example.

As was agreed at the World Economic Summit at Williamsburg and again in Washington in January, intervention can sometimes play a useful role in limiting such currency surges. By "burning the speculators' fingers", as it is called, one can change their perception of the balance of risk and reward. To succeed, such exercises must be concerted and they must throw very substantial sums of money into the market at the right moment. While they can neutralise or diminish short gusts of speculation or even tip the balance when the market is near the turn, they are no answer to a prolonged gale.

As the House will realise, the commitment to intervention which was recently strengthened at the Group of 5 meeting is real and it has been effective. This was vividly borne out only last week, when concerted intervention by a number of central banks was undertaken on a significant scale.

To sum up these brief remarks on the causes of instability and how one should respond, where it arises from divergent domestic policies, or fear of it, there is a clear international agreement that governments should act to put their economies right. The United States acknowledges this, but does not find it easy to act, because the effects of what it is doing wrong are not politically felt at present by its own population. We acknowledged the fear recently and have acted.

Where major changes in the external environment are the cause—such as oil price changes—there is little governments can do. We can only ask for realism; and, over time, realism is what we tend to get. Where speculation and market overshooting occur, intervention can play a useful if limited role, and is being implemented to some effect.

Our Government have been in the lead in promoting the understandings which emerged about both the need for convergent domestic policies and the prudent use of intervention. My right honourable friends Sir Geoffrey Howe, the Chancellor, and the Prime Minister went a considerable way to obtaining international understanding on this in achieving the Williamsburg agreement which enshrines it all.

Some speakers in this debate believe that we could and should have done more, in particular by joining the exchange rate mechanism of the EMS. The analysis I have offered should make it clear why such a move would not have helped. It would have done nothing to prevent the general rise in the dollar against all other currencies. It would be no defence against upward or downward pressures on sterling arising from its perceived petro-currency status—pressures to which we are still exposed. It is not an "easy option"—a way of side-stepping day-to-day speculative pressures. Nor would it remove the need for firm domestic policy; indeed, adherence to EMS parity limits requires painful policy changes when the currency is depressed—such as higher interest rates or lower public borrowing.

As the House will recall, we debated our full participation in the system in November 1983. Then and subsequently the Government's position has been made very clear. We are ready to join when the circumstances are right. We believe that full membership will then have significant advantages. We review the position regularly and I shall see to it—and this is more than simply a form of words—that this debate is considered most carefully by Ministers. But I hope I have also made it clear that recent events in themselves do not suggest that our position is wrong at present.

Lord Ezra

My Lords, does what the noble Earl is saying mean that the Government still do not consider that the time is right for joining in spite of a growing body of opinion which appears to favour it?

The Earl of Gowrie

My Lords, I hope that the noble Lord, just as I will refer his speech to the Chancellor, will do me the courtesy of reading my arguments. I have tried to argue fairly closely as to why I do not think the time is right at present. It certainly would not have had the effect of sheltering us from some of the experiences we have had in the past few months.

However, I take very seriously the question of exchange rate stability. I do not believe in taking soft options or cutting corners. Indeed, if we were to do so we should undermine the very real progress we have made in conquering inflation and providing the necessary conditions for sustained recovery. The fundamental problem for the stability of exchange markets remains the excessive strength of the dollar. We welcome the United States Government's resolve to tackle their unsustainable budget deficit and we have been encouraged by last week's indications that market sentiment may now be changing.

My last point is this. At home our role is the continued pursuit of sustainable growth by maintaining downward financial pressure on inflation. That was the burden of my whispered asides to the noble Lord, Lord Barnett. Doubts about our resolve in that respect did, in our judgment, contribute to the recent volatility in sterling. I believe that these doubts have now been well and truly laid to rest. In the long run the best contribution we can make towards achieving greater stability for sterling is to continue with an economic strategy that has borne fruit, is bearing fruit, and will continue to bear fruit.

I must say to the noble Lord, Lord Barnett, and the House that I do not rely on selective statistics. I rely on company profitability, consumer spending and the evidence of my eyes and ears in most parts of the country. Of course registered unemployment is too high. But I put it to the noble Lord, Lord Diamond, that we in this country have a huge work force, a huge number of people in work—no less than the same proportion (at 66 per cent.) of the 16 to 65 year-old age group as has the United States of America.

The strategy I have mentioned, and which the noble Lord, Lord Barnett, asked about, will surely be strengthened by the end of the miners' dispute. The strike cost us over 1 per cent. of gross domestic product in 1984 and we should recoup most of that soon in a year in which GDP is already set to grow strongly. I have to say to the noble Lord, Lord Barnett, that it seems extraordinary to me that he should suggest that our currency of our economy would in some way have profited had we caved in, the third successive Government to do so, to monopoly public sector trade unions. The strike also weakened our balance of trade, partly because of the extra oil burnt in place of coal; so, as oil trade reverts to normal, the trade balance will improve. Non-oil exports, which were up by over 11 per cent. in the last quarter of 1984, should also contribute handsomely.

It would be reasonable, then, to expect a general improvement in business confidence, not least in relation to capital spending, which is, I have to say to the noble Lord, Lord Ezra, already set to rise by 7 per cent. this year in manufacturing industry. These and other favourable developments should consolidate the creation of new jobs, of which the Department of Employment now estimate nearly half a million net have been added since March 1983. All in all, then, we are no longer talking, with the noble Lord, Lord Kagan, about light at the end of the tunnel but light now beside us to help us on our way.

House adjourned at twenty-five minutes past nine o'clock.