The Whitlam government and Modern Monetary Theory: a new perspective

Feb 12, 2023
Gough Whitlam 1973

Hindsight is a wonderful thing and it particularly applies to the Whitlam government’s ‘loans affair’.

The events leading up to the dismissal of the Whitlam government in 1975 were complex, fascinating and ultimately tragic, especially for Australian society. I will not reprise the key facts here as they are readily available, especially if one reads Jenny Hocking’s excellent book The Palace Letters (2020). It was a shameful period for many conservatives – including ongoing attempts to quarantine the letters – where their antidemocratic natures were on full display.

The loans affair – where minerals and energy minister Rex Connor was authorised in late 1974 to borrow up to $US4 billion via the Pakistani intermediary Tirath Khemlani – was a losing gambit for the Labor government and Connor was sacked as minister in October 1975 when it emerged he had misled parliament over his ongoing contact with Khemlani. (Treasurer Jim Cairns had also misled parliament and had been demoted.) Connor’s error was the straw that broke the camel’s back for the Fraser opposition and it decided to block the budget bill (defer supply) soon afterwards.

If Whitlam and his advisers had understood modern monetary theory (MMT, although it was not formulated until decades later) there would likely have been no loans affair.

Central to MMT is the principle that a monetary sovereign nation is one with (i) its own currency; (ii) a floating exchange rate; (iii) no significant borrowings in a foreign currency; and (iv) its own central bank to create the money it needs.

US president Nixon had ended the gold standard in 1971 whereby the US dollar had been tied to the value of gold (Nixon effectively ended the post-World War II Bretton-Woods agreement). The US dollar then became a ‘fiat’ currency, like Australia’s now, whose value rested entirely on government decree rather than being pegged to another commodity.

Australia did not adopt a floating exchange rate until 1983. Before then, the government had pegged the dollar to the British pound, but then pegged it to the US dollar in 1971. The Whitlam government was elected in 1972. In 1974 the dollar was pegged to the Trade-weighted index. All this manoeuvring suggests considerable volatility and wringing of hands. What made matters worse was the OPEC oil shocks from 1973 that triggered considerable inflation, a wage-price spiral, and eventually stagflation (high inflation and unemployment, together with slow economic growth). The Fraser opposition blamed Whitlam for what was essentially an international crisis.

Nations with a fixed exchange rate – a peg – need to adopt policies to strictly defend the exchange-rate promise. A floating exchange rate frees the government from such a promise, giving it more policy options (although the government, especially via its central bank, will still adopt policies to limit exchange-rate fluctuations).

If the Whitlam government had floated the Australian dollar, and avoided borrowing in foreign currencies, it would have become a monetary sovereign and could never become insolvent. It could have created all the Australian dollars it needed via its central bank, as the Australian government does now – as long as the votes are there to pass the spending bills and other legal niceties are met (including rules about so-called off-budget spending).

Of course, there are limits to prudent money creation and spending – whether that money is reserves created by the central bank or credit money created by commercial banks. One limit is inflation: too much spending will be inflationary. Another limit is exchange rate fluctuations, which a government will want to keep within certain bounds. The other limit is environmental sustainability: too much spending will destroy too much natural capital via increased production-consumption. (However, money creation and an increased money supply do not automatically translate to identical increases in spending.)

The Whitlam government sought to borrow potentially low-cost Arab petrodollars to develop Australia’s energy resources. It had decided that foreign financial capital was needed to do this. The better course, as MMT now teaches, would have been to float the Australian dollar and avoid borrowing foreign currencies. Foreign currencies – especially the US dollar – are available via international trade and are needed because some commodities by convention are only traded (contracted for) in US dollars. But the best course is to minimise the need for international trade and foreign currencies.

The Australian government today still does not seem to understand what it means to be a monetary sovereign. It does not need foreign financial capital for investment. Wealth is determined by available real resources, transformed into capital equipment and consumer goods and services at a sustainable scale, relative to the size of the population. Knowledge, training, technology and the rule of law are critical, but foreign financial capital is not. ‘Selling the farm’ is not the answer, with profits and real resources continually draining from Australia. In fact that’s what the Whitlam government sought to avoid – a US or European loan that depended on part-foreign ownership of the investment project.

In short, the Australian government in 2023 can buy anything for sale in Australian dollars. If something is physically possible – technically possible – the Australian government can afford it (with the above mentioned caveats). But no amount of Australian dollars in a government piggy bank would help if something was not physically possible: i.e., if the real resources or knowhow were not available.

Reliable information on MMT can be found in the MMT textbook, Macroeconomics (2019) by Mitchell, Wray and Watts; and at Modern Money Lab, based in Adelaide. The latter now run online courses, up to PhD level, in association with Torrens University.

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