During the 1920s, Australia sees economic growth and large scale immigration. However, the Depression of 1929 halted these trends. Australia remained dependent on Britain for defence. In 1934, Australia introduces a so-called "three-year plan" for re- armament. Although Japan had been an ally in the First World War, Japanese economic growth and the rise of Japanese militarism made Japan a threat in Australian eyes. In 1938, the export to Japan of important raw materials, such as iron and manganese were banned.

Australia and New Zealand declared war on Germany in 1939 along with Great Britain. Australian and New Zealand troops see heavy fighting in the North African desert campaign against the German Afrika Korps of General Rommel. Ground forces also participate in the Italian campaign. Australia itself experiences little fighting during the war, but after Japan joined the struggle in 1941, some Australian cities, such Darwin suffered heavy damage from air raids. Australian and New Zealand military forces, ground, air and naval, all participated in the campaigns throughout the South Pacific and Southeast Asia.

Japan attacks the United States with the raid on the Pearl Harbour naval base in Hawaii. The Philippines is invaded and conquered by Japan by early 1942. The island groups of the South Pacific are the scenes of major air, naval and ground battles between the Americans and Japanese.

The battle of Midway in June 1942 is a turning point in the Pacific war. The Japanese aircraft carrier fleet suffers huge losses and Japan is now forced onto the defence. The American counter-attack against Japan leads to bitter fighting. Some important battles include Guadalcanal, Tarawa, Leyte Gulf, Iwo Jima and Okinawa.

Immediately after the war, Bikini Atoll, an island in the Marshalls group in the South Pacific, was selected as the main US nuclear test site. Between 1946 to 1958, 23 atomic bomb blasts were made here. The 167 people who lived on Bikini island were moved off. Only now, in the 1990s, have plans been started to clean up the radioactivity on the island to allow the 80 or surviors, plus their families, to move back.