Australia And The Depression Essay, Research Paper

Responses by Australian governments to the Great Depression were largely inadequate; however, it is necessary to identify the sources of these inadequacies. Attempts made by the Scullin Government to implement effective policy responses to the problems of the Great Depression were significantly impaired by a number of factors; consequently relevant policies are analysed separately. Among the impediments were a lack of support from London, New York and Australian Bankers, conflict with the Commonwealth Bank, large opposition in the Senate and limited spending powers. All of these factors meant that Australian Governments did not have the statutory or political power to adequately handle the Great Depression.

The Federal Government’s influence over monetary policy exemplifies this. Although the Federal Government and the Commonwealth Bank were the official monetary authorities, they had little direct influence on monetary policy. Monetary policy was controlled by private banks, and so monetary policy reflected their market response to economic circumstances. Banks determined short-term interest rates through their competition for deposits and were key planners in the foreign exchange market during the early years of depression. The fact that Sir Robert Gibson was Chair of the Commonwealth Bank only added to the Governments predicament. Gibson’s thoughts on economic policy were conservative, and under existing legislation, he was answerable to no one except the Bank Board, which he dominated.

Consequently, the Government lacked the necessary power to significantly influence to the board in favour of their policies. This lack of means was sorely missed during the crisis in government finance. Australia depended heavily on overseas borrowing for new investment. However, the returns from the investments were not sufficient to satisfy debt repayments and so the government persistently used overdrafts. In the later half of 1929, Australia’s external debt position worsened. When the government approached the banks to extend further overdrafts, the banks refused. The banks argued that if sufficient funds could be found to repay the maturing Treasury bills, funds could also be found to reduce overdrafts

(Schedvin 1970 p137). Australia began a near exhaustive sale of gold

reserves which ended in mid 1930’s.

After a number of bankers conferences, the Mobilisation Agreement was

signed. This provided a means for financing current public debt obligations in London. The banks were to provide sufficient funds ( 3 million per month) to cover the interest repayments but not the principal of the debt. The banks now had a substantial level of control over the government which reduced the government’s means to deal with the problems of the Great Depression even further. This surfaces later when Scullin attempts devalue Australia’s currency.

The Scullin Government was determined to honour foreign debt obligations; however it was faced with a trade-off. Maintaining parity with Sterling meant that Australia’s currency was overvalued. The Scullin Government believed maintaining parity to achieve external balance was deflationary and could lead to an increase in unemployment and demand for unemployment benefits. However, Scullin also believed parity would reduce demands on scarce revenues to meet foreign interest payments which would subsequently yield a greater degree of fiscal flexibility (Butlin et al 1985 p7).

Furthermore, the Scullin Government recognised that an overvalued currency would depress export income further and cause an increase in demand for government assistance. For these reasons, the Scullin Government gave its support to devaluation.

Contrary to this, the banks (including the Commonwealth Bank), were

concerned about the inflationary consequences arising from devaluation. Devaluation was unfairly ruled inflationary due to the money/price relationship and the fact that wage increases were based on the quarterly adjustments in the cost of living. This may represent a lack of theory at the time, although this opinion was held by the Banks and not the government. The discordant relationship between the Scullin Government and the banks (including the Commonwealth Bank) began to deteriorate further.

The outcome of the stubborn bank’s disagreement with the Scullin Government was a delay in the devaluation. Despite the rapid fall of foreign exchange reserves, and the weakness of commodity markets such as wheat, the devaluation did not occur until January 1931. Figure 1.0 shows the Anglo-Australian exchange rate from 1929 to 1931.

Figure 1.0 Anglo-Australian Exchange Rate, 1929-31

(Adopted from Schevin, 1970, p155)

[Image]

Note : Buying rate for telegraphic transfers expressed in Australian currency for 100 sterling.

The delay in devaluing had a significant adverse impact on the incomes of exporters and on the process of recovery. Had the currency devalued earlier, the burden of adjustment on other policies would have been smaller and the recovery may have commenced sooner (Butlin 1985 pp205). The low level of foreign exchange reserves in 1930 was a major factor in forcing acceptance of major cuts in government spending which, in turn, withdrew a potential fiscal stimulus from recovery. Moreover, failure to devalue until 1931 deferred the improvement in the price competitiveness of traded goods industries, notably manufacturing, that Schedvin and others have argued was

the main engine of economic recovery.

The delay in devaluation had secondary effects on decisions made in other policy areas. The low level of foreign exchange reserves was a major factor in the acceptance of contractionary fiscal policy. The delay in devaluation also meant a delay in encouraging the price competitiveness of industries in the traded goods sector. In particular manufacturing, which is thought, by some, to be the driving force behind recovery. Valentine’s simulation results also show that, “..devaluation would have reduced unemployment and

increased GDP through the 1930’s” (Valentine 1978 pp165). Valentine also suggests that had the Scullin Government been able to implement its policy initiatives, the stimulus would have been greater.

Nevertheless, the eventual devaluation provided the positive effects

outlined above including the greater incentive for investment in

manufacturing and the rural sector (Sinclare, 1985, pp4).

From 1930 through to 1931, Australian governments faced severe declines in income and employment. Disputes on an appropriate remedy for the problem of mounting budget deficits grew between the Labour governments and the banking system. The main difficulty for the Commonwealth Government was the fall in customs revenue, on which its budget depended heavily. Another problem was the mounting interest on publicly owned debt which equalled around 54 million (60 per cent of taxes); the foreign half of the debt equalled just under one-fifth of the value of exports (Pincus 1985 p82).

Three main policy initiatives emerged. Once policy option was to maintain the deficit at its present level while increasing expenditure on unemployment relief. Another proposal came from J.T. Lang, Premier of NSW, who proposed a default on the overseas debt, to allow increased expenditure on unemployment relief. The third was to decrease both government expenditure and real wages.

Had the 25 million worth of foreign public debt been used to reduce the current account deficit by default, then it is estimated that pressures on the exchange rate would have eased and unemployment may have been cut by half (Shedvin 1970 p373). Butlin argues that had the monetary authorities rescheduled or defaulted on payments of interest and principal on official external debt, the extent of the downturn would have lessened and faster economic recovery would have been encouraged (Butlin et al 1985 p2).

However these outcomes depend upon the assumption of no retaliation by the British, and no adverse effects on domestic confidence.

Be that as it may, the Labor Government was under considerable political pressure. Theodore’s dismissal and re-instatement over the Mungana incident, and Scullin’s departure to the Imperial Conference did not create the environment required to ’sell’ a default. The large Opposition majority in the Senate hampered government measures on every possible occasion. As it was unable to implement its own policy and unwilling to face a general election, the government had little alternative than to accept a compromise which favoured the opposition. This is a clear example of the Governments lack of will and it also represents a lack means to implement policy since

the Senate was dominated heavily by the opposition. Moreover, the Labor Party was in the process of a politically damaging fragmentation, evidenced by the resignation of Fenton and Lyons (Minister for Customs and Excise and acting Prime Minister respectively ) over the reinstatement of Theodore. This allowed the Bank and the Senate to apply pressure without fear of retaliation. These pressures culminated in the signing of the Premiers’ Plan.

The goal of the Premiers’ Plan was to bring domestic costs of production into line with lower international commodity prices. It was intended that this plan would restore profits to the trading sector and encourage investment at the same time (Valentine 1978 p165). It embodied five major provisions: A 20 per cent reduction in all adjustable government expenditure; conversion of the internal debts of the governments on the basis of a 22 + per cent reduction of interest; increased Commonwealth and State taxation; reduced bank interest rates; and relief for holders of private mortgages (Cook 1970 p99).

Scullin firmly announced on several occasions that he would not default, but he was also publicly committed to maintaining pensions. The limited access to sufficient resources resulted in the government’s inability to afford the redemption of 5 million worth of Treasury bills that were to fall, due in mid 1931. The legislation to permit the sale of gold overseas (to cover these costs) was defeated in the Upper House. Scullin was forced to choose between pension cuts or loan default.

To influence the Scullin Government’s decision, the banks added further pressure with an ultimatum:

[the Board] cannot undertake to continue to accept further obligations unless, and until, it is placed in a position of definite assurance of arrangements whereby considerable relief is obtained overseas to ease the position the Board is not prepared to proceed upon a course which the dictates governing real responsibility and common sense indicate as absolutely unsound The Board is of the opinion that the position is so serious as to indicate that reductions of expenditure should be made where such can be done without infringement of the Law (Schedvin 1985 pp179).

Either the government undertake measures to implement a cut in the Basic Wage, increase the level of protection for secondary manufactures, freeze access to sterling balances, increase taxes and lower government expenditure or the bank would be unable to provide finance. To try to protect British interests, the Bank of England sent a team lead by Sir Otto Niemeyer to Australia. After an examination of Australia’s financial position, Niemeyer concluded that Australia should cut wages and balance the budget at all costs (a position firmly supported by many of the private banks). The breakdown of the sterling exchange standard, the near exhaustion of London funds, and the export of almost all available gold reserves meant that the government could do nothing else but agree to the

Premiers’ Plan. The Premiers’ Plan was signed by Scullin and all six State Premiers on 10 June 1931.

The outcome of this is show in Figure 2.1 below. Figure 2.1 shows a plot of the aggregation of Commonwealth and state deficits along with net loan expenditure. The summation indicates that the Premiers’ Plan was profoundly deflationary. Prior to mid-1931, the level of revenue expenditure was well maintained and the growth of budget deficits tended to compensate for the fall in loan expenditure. During most of the contraction, it would appear that by substantially eliminating deficits and by further reducing loan expenditure, the effect of the plan was to hinder recovery (Schedvin 1970 p295).

Figure 2.1

(Adopted from Table 34 of Schedvin)

[Image]

Other evidence that indicates the Premiers’ Plan was inadequate is drawn from simulation experiments conducted by T.J. Valentine. The simulation shows the effects of the Premiers’ Plan by considering what would have happened if the changes involved in the plan had not been introduced. “The interest rate cuts provided stimulus, but the expenditure cuts were contractionary” (Valentine 1978 pp165). This view is also held by others including Schedvin, “..the premiers’ plan was unambiguously deflationary, for it involved a sharp fall in government expenditure and hence in aggregate demand” (Schedvin, 1970, pp252).

It is argued that Australian Governments did not have the theory to

adequately handle the Great Depression. “Fiscal policy [when] judged from the perspective of Keynesian multiplier analysis did intensify the effects of the depression” (Maddock 1985 pp17). Keynesian macroeconomics suggests that in order to recover from depressions or recessions, a stimulus to aggregate demand is required. Examples of measures to bring this about are, increases in government expenditure, reductions in taxation and reductions in interest rates. Classical economics, on the other hand, focuses on the supply-side of the economy. Classical economists such as Niemeyer, prescribed reductions in wages and improvements in productivity to remedy depressions and recession.

Many argue that Keynesian alternatives were not available until Keynes’s General Theory was published in 1936. However economists world-wide were prescribing expansionary fiscal policy measures such as government spending and public investment to relive unemployment, while condemning wage reductions for fighting depression (Clark 1981 p179).

Keynes’s promotion of public investment programmes was included in his book A Treatise on Money which was available to Australian Governments in 1930. Premier Lang borrowed quotes from A Treatise on Money in his organisation’s pamphlets. The book demonstrates that a lack of investment will lead to falls in output and employment. Keynes argues that financing investment through an expansion of the money supply (not wage reductions) would lead to greater employment. Scullin was indeed aware of the need for credit creation and he proclaimed this only a few weeks after becoming Prime Minister. The arguments outlined previously highlight the simple lack of funds to carry out this task. The government could not borrow from London or New York, Australian Bankers would only cover the day to day running

costs and the large opposition in the Senate meant Scullin did not have the statutory or political power to carry out public investment programmes.

Another theoretical debate among government authorities concerned the role of tariffs. Supporters of free trade suggest that protection hindered our exporting industries and reduced are export income. However, tariff preference under the Ottawa Agreements of 1932 diverted British demands toward Australian goods with visible exports destined for Britain rising by 13.2 per cent (Eichengreen, 1985, pp51). Protectionists argue the presence of higher tariffs maintained a larger manufacturing base. This may be true in the sense that many manufacturing industries were born out of manufacturing protection during depression. Examples include companies such as Kelloggs, Nestle and ICI. Therefore, although modern theory suggests that tariffs reduce national income, in reality it assisted a number of

manufacturing firms.

The Australian Government’s attempts to implement an effective policy

response to the problems of the Great Depression were significantly

impaired by the lack of means and will. This resulted in contractionary fiscal and monetary policy as well as a delay in the devaluation. Contrary to what some historians believe, there was not a lack of theory. Many economists supported expansionary policies such as increases in government expenditure while condemning contractionary wage cuts. The final outcome was to prolong the depression.

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