The two leaders met on the fringes of a European summit in Hanover where Mrs Thatcher warned the taoiseach: “We can’t have the border open as it is now.”
“There are massive caches of arms somewhere,” she said.
“We know that there are arms and weapons and we know that they bring them across.
“We do not get intelligence from the Gardai, they are not the most highly professional police force.”
The taoiseach rebuked Mrs Thatcher saying the Irish government was “constantly ballyragged” by the British and received “no credit” for the work they had been doing.
“There were 147 punishment shootings in Northern Ireland in a recent period,” he said.
“You had Lisburn. You had Enniskillen. These are not failures of our making.
“These are things that happen within Northern Ireland where your security forces operate.
“There is no way we can patrol 500 miles.”
Mrs Thatcher, who continued to become increasingly exasperated in the meeting added: “I don’t know what to do about the border.”
She went on to say she was disappointed in the SDLP and John Hume.
“They have the gift of the gab, but no, they won’t talk to their people and tell them to join the RUC. So I have failed,” she said.
“When the troops went to Northern Ireland, they were welcome. It has all been so useless…
“Those two corporals (Derek Wood and David Howes, who were caught up in a funeral procession of an IRA member as they returned from Belfast to Lisburn were killed on March 19 that year) were among the worst things in my life. The savagery was unbelievable.
“I will never be prepared to walk out and let the terrorists win.”
The meeting came in a particularly tense time for the two leaders as Mrs Thatcher had written to the taoiseach in April telling him she was “deeply upset” at speeches he had made in New York and Harvard.
“You seem to be arguing that the persistence of violence actually calls into question the existence of Northern Ireland as an entity. To me, such an admission would be tantamount to a surrender to terrorism,” the letter read.
Mr Haughey had made it clear to the British leader in a secret message four days before the meeting that he utterly rejected violence.
“As an Irishman it has always been a matter of deep regret for me that Ireland is divided.
“A united Ireland could not come about through violence, and every act of bloodshed on this island sets back further the date when what I hope for most deeply can be achieved.”
During the meeting, Mrs Thatcher brought up Mr Haughey‘s political belief.
“You talk of unity and I ask would that be better? I say no, there would be the worst civil war in history, she said.
“And it would spread to the mainland. Your people come over to us. I wish they wouldn’t. They come looking for housing and services.”
A press release dated after the meeting said that “a great deal of useful work had been done”.