On 12 October 1929, James Scullin led the Labor Party to what was then its largest ever majority. It was unfortunate timing. Over the 1920s Australian governments had become the largest borrowers on the London money markets. In 1925, the United Kingdom returned to the gold standard. And then on October 24, just twelve days after winning its record breaking majority, Wall Street collapsed.
Looking back, this period became a textbook example of what not to do in economic policy. Scrambling to make good on our debts to London, Australian governments desperately tried to balance their books, only to plunge the country deeper and deeper into depression.
Labor faced a difficult set of circumstances. Australia’s identity was bound to the UK. Our defence strategy and economic strategy were effectively subordinate to the UK’s. Labor was also eager to demonstrate its economic credibility. And the dominant economic thinking said the books must be balanced.
In 1931 Labor was wiped out. It had already split internally through the pressures created by the Depression. Federal Treasurer Ted Theodore argued for a new economic orthodoxy, based on what at the time seemed like the radical teachings of John Maynard Keynes. NSW Premier Jack Lang rejected paying London banks over the livelihoods of NSW workers. Both were ignored and Lang was eventually dismissed by the Governor, leading a group of Labor MPs in a split.
By the 1940s, when Labor was again in office during a new period of crisis – the Second World War – both orthodoxies were being overturned. John Curtin looked to the USA rather than the UK as an ally. Ben Chifley looked to Keynes for post-War reconstruction and to enshrine full employment.
The last few weeks have felt unnervingly similar to those inter-War years. A Labor Government with a record majority, acknowledging a crisis but nervous about questioning economic orthodoxy. Rather than London bankers, orthodoxy is now imposed by our own ‘independent’ central bankers and economic commentators.
But what has occurred in the Strait of Hormuz has not been an orthodox economic event. Economics has not changed ‘at the margin’ as economists like to say – we have witnessed an economic earthquake and applying the old rules will only make it worse.
Our current economic orthodoxy is a variant of the version Scullin faced in 1929, and reflected a similar context. Then and now, the orthodoxy reflected – and encouraged – a globalised world of free trade and free markets. It was deeply sceptical of government and used monetary policy – the gold standard then, inflation targeting now – to deter adventurous governments. Spend too much, interest rates will rise to smother expectations, demand and jobs. Better to let markets sort it out.
However, the old play book is making less and less sense. Already through the Global Financial Crisis, and then again during the pandemic, the central bank seemed to throw out the play book in response to impending disaster. The problem in both cases was not too much or too little demand per se, but a collapse in confidence and liquidity as events overtook any rational expectation of what might happen next. Instead, central banks took on something like the role of government, flooding economies with money and acting as buyer, insurer and underwriter of last resort. Coordination between the central bank and government wasn’t perfect, but successfully insulated people’s jobs and houses from the crisis. This crisis threatens to be a very different experience for Australian households.
The last few years have seen a determined effort on the part of mainstream economics to reassert the old rules. As inflation started to spike in the wake of the pandemic an argument erupted over its cause. Was this a demonstration that spending (now blamed on governments rather than central banks) always has a price? Or was it the delayed effect of logistics disruptions exploited by the oligopolistic power of big corporations who dominate important supply chains?
There is evidence of both causes. But Australia, again keen to prove its economic credentials, has followed the economists in reasserting the old orthodoxy. Inflation must be prioritised, even if it means a recession. Confidence that the Bank has the credibility to do what it takes to ‘tame inflation’ must be restored.
It leaves us in an unsettling position. Again our defence is tied to a superpower that shows little interest in our wellbeing, and our economic strategy is subordinated to an orthodoxy that treats as obvious the need for the Reserve Bank to raise interest rates as prices rise no matter the cause.
Yet, the logic of raising interest rates – to lower demand and thus prices – has no obvious connection to the present economic reality. Petrol prices have not risen because of excess demand. Whether or not the ceasefire holds, food, building materials and other prices will soon follow. This too will reveal nothing about demand. The marginal inflationary pressures that were concerning the Reserve Bank before the war on Iran have been completely superseded. Prices are rising because of a geopolitical crisis, the kind of crisis essentially assumed away during the high tide of globalisation that saw the ascendency of the current economic orthodoxy.
But what if the crisis isn’t really a ‘crisis’ at all, but a new normal? What if economics is now intimately tied to unstable geopolitics? Asserting the old rules in this new world of disorder might simply magnify the shocks – just as it did in the 1930s. The time is ripe to recognise the limits of conventional monetary policy in the current juncture and look towards emerging alternatives.
Just as Ted Theodore was already looking to Keynes in the 1930s, a new economic orthodoxy is already emerging. Looking to China, Isabella Weber sets out the importance of price and investment controls to manage an unstable world. Those tools not only reflect China’s recent success, but also the lessons it learned from the rise of its East Asian neighbours, and even from wartime economic policy in the USA. Rather than letting prices gyrate with supply shocks, governments can act at both ends to foster economic resilience – taxing super profits and stabilising prices.
To do so, governments might take another lesson from recent economic success by instituting greater state control of key resource exports. State capitalism, as Ilias Alami and Adam Dixon call it, has seen governments step into market economies through publicly owned energy companies and sovereign wealth funds financed by energy exports. Governments can then shape investment, providing long-term support to shift economies in directions we know are needed to insulate us from shocks that will only cascade with climate change, particularly by transitioning from fossil fuels to renewable energy produced in Australia.
Fortunately, we are starting to move in these directions. Our climate policy is increasingly guided by state managed investment funds. When the Iran War broke out, the government announced it would underwrite oil importers to stabilise price shocks. But it remains nascent. Like Scullin, the current government appears nervous to question the orthodoxy out loud or make change on a scale commensurate with the challenges of our new economic reality.
The Depression not only ruined lives through unemployment, it fostered a breeding ground for a new and dangerous politics. In December 1931 Labor lost its record majority in a single blow on the back of a 15 per cent swing. The consequences were far more dramatic elsewhere.
History rarely repeats. But it often rhymes. Today, petrol prices and mortgage rates hit very similar households, none of whom caused the War or make windfall profits from rising gas prices. The world has changed. If governments do not change with it, they will be swept aside, with potentially terrifying consequences.
When economists talk about how changes to fuel taxes change behaviour at the margin, or why helping households only encourages the Bank to raise rates, think about what is causing the crisis. The old economic toolkit cannot see what is happening. Continuing to use it isn’t just foolish, it’s dangerous.
First published on Pearls and Irritations.
Author: Gareth Bryant
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