The prime minister last night faced her bleakest hours since she came to power after Mr Nigel Lawson shook the Government to its foundations by resigning as Chancellor.
Mr Lawson told Mrs Thatcher she had a choice between him and her personal adviser, Sir Alan Walters.
Mr Lawson's resignation forced a cabinet reshuffle only four months after the Prime Minister had put a new team in place. Within three hours of his departure, Mrs Thatcher had appointed Mr John Major as Chancellor, Mr Douglas Hurd as Foreign Secretary and Mr David Waddington as Home Secretary. Sir Alan, whose public behaviour as her economic adviser provoked the crisis, resigned last night by telephone from his Washington home.
Mr Lawson told Mrs Thatcher in his resignation letter that the successful conduct of economic policy was only possible 'if there is, and is seen to be, full agreement' between the Prime Minister and the Chancellor.
Recent events confirmed that this requirement could not be satisfied 'so long as Alan Walters remains your personal economic adviser'.
Downing Street said last night that Mr Lawson first suggested he might resign at 9am yesterday. He and Mrs Thatcher had met on Wednesday night when he again attacked Sir Alan's public interventions in the debate over economic policy and demanded his resignation.
Mr Lawson failed to get the repudiation, and Mrs Thatcher's half-hearted defence of him at Commons question time convinced him his position was untenable. She was told he had decided to resign as she left the House at 4.15pm, having been taunted by Mr Neil Kinnock that there were two Chancellors running the economy.
They met again in her study when she made a last futile effort to dissaude him from leaving the government. Barely an hour later Mr Lawson's formal letter was sent to Downing Street and Mrs Thatcher replied almost immediately, fearful of the impact on the markets. She told him she accepted his resignation 'with the most profound regret'. She named Mr Major, Foreign Secretary for only three months, as Chancellor.
An hour later, at 7pm, it was announced that Sir Alan had also resigned from his part-time Pounds 31,000-a-year job as her official economic adviser.
After hearing the news of Mr Lawson's resignation, Sir Alan telephoned Mrs Thatcher and said he was stunned by Mr Lawson's decision and insisted he had to quit, too.
Mr Lawson's decision to resign after 6 1/2 years, in which Sir Alan has engaged him in a war over the conduct of economic policy, openly split the Conservative Party.
The left of the party was dismayed at the appointment of Mr Major, complaining he was 'a bunker man' whose stewardship of the Treasury would be firmly under the control of Number 10.
However, Treasury officials said last night that Mr Major did not differ in his economic views from Mr Lawson, under whom he had served as Chief Secretary. This raised the possibility that Sir Alan's resignation was a condition of Mr Major taking the job.
Mr Major expressed sorrow about Mr Lawson's resignation and said he would maintain existing policies to deal with inflation which remained the Government's main priority. 'Monetary policy is tight and is beginning to have its effect. I shall keep it tight for as long as necessary.'
Mr Lawson's hand was forced by the publication of renewed criticism by Sir Alan of his belief in the necessity to join the Exchange Rate Mechanism of the European Monetary System. Sir Alan described EMS as 'half-baked' and revelled in his claim that a small but beleaguered minority in Government were managing to hold the line against the Treasury.
Sir Alan has consistently argued for letting the pound find its own level, a view supported last year by Mrs Thatcher when she said you could not 'buck the markets'. The differences between Sir Alan and Mr Lawson undermined the Chancellor's firm exchange rate policy, since the markets could not be confident that Mrs Thatcher would approve the interest rate rise or the intervention needed to hold the exchange rate.
The uncertainty about policy has been one reason for the sharp falls in sterling which began with the Pounds 2 billion August trade deficit.
On Tuesday, Mr Lawson said it would be better if Sir Alan said nothing more in public and then reiterated the point more ferociously in an extraordinary television interview. He wanted a clear repudiation by Mrs Thatcher of Sir Alan in the Commons. Instead, when she was asked by Mr Neil Kinnock if she was going to get rid of the part-time Chancellor, she tersely replied: 'Advisers advise, ministers decide.'
Mr Kinnock said last night Mrs Thatcher had been severely weakened by the blow. 'She is the person who said how energetically and enthusiastically she supported him.' He claimed she would not allow the people she appointed to senior departments to do their job. 'This was the straw which broke the camel's back. The only thing that has kept him from resigning was that further damage would be inflicted on the economy and the level of the currency.'