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Why Turnbull Needs To Worry About 'The Latham Effect'

With Mark Latham out the door, it's a good time to remind ourselves what did him in the first time round...

30/03/2017 9:52 AM AEDT | Updated 30/03/2017 10:14 AM AEDT
The Sydney Morning Herald via Getty Images
"Latham was, to say the least, erratic in his leadership style, and Howard knew that if he could link that character flaw to voter’s sense of economic security, then he would win in a landslide."

It's not been a good week for Malcolm Turnbull. On Monday, the polls took another dive. On Tuesday, he was humiliated over an extradition treaty with China. On Wednesday, he lost his temper in parliament.

But worse than all that, Turnbull is now facing the biggest electoral poison any Australian politician can face: interest rates are going up.

Thing is -- none of this is unconnected. As John Howard pointed out 13 years ago: erratic leadership leads to higher interest rates.

As Prime Minister, Howard was many things, but trustworthy was not high on the list. Like any brilliant politician, Howard was a master at dissembling and using words to tell the truth without getting too close to the whole truth.

Turnbull is now facing the biggest electoral poison any Australian politician can face: interest rates are going up.

And fair enough -- that's a politician's craft. But that's why, in 2004, when he launched his bid for re-election, people were startled at what Howard claimed the theme of the election would be: "This election, ladies and gentlemen, will be about trust," he declared to barely suppressed guffaws from Labor opposition MPs across the land. Then came the kicker: "Who do you trust to keep interest rates low?"

John Howard had zeroed in on then-Opposition Leader Mark Latham's key weakness. Latham was, to say the least, erratic in his leadership style, and Howard knew that if he could link that character flaw to voter's sense of economic security, then he would win in a landslide.

As it turned out, he could and he did.

At the time, economists were rather amused by Howard's claim to be able to control interest rates. After all, ever since 1960, the people who set interest rates -- the board of the Reserve Bank -- had been above the control of governments. And since the Australian dollar floated in 1983, interest rates were governed by the tides of global economic forces. Outside of major nation-building exercises or, say, declaring war, political policies had marginal influence over those forces.

But Howard's argument had a kernel of truth to it. One thing that drives interest rates higher is erratic policy-making.

Conversely, the one thing that our politicians can do to keep interest rates stable is to provide a methodical policy framework that doesn't jump from brain-wave to brain-wave on a leader's latest whim.

Call it 'The Latham Effect'. In an environment where the fundamental stability of government policy is undermined, the cost of doing business in the country rises, and that impacts on interest rates. And that's exactly what we're witnessing under Turnbull.

This is why Latin American economies always have higher interest rates than their European counterparts. Latin American economies tend to have more erratic governance. Over time, businesses investing in those countries price in that risk. They demand higher returns to take into account the fact that their whole business model may have to change on a leader's whim.

And it's also why electricity prices in Australia are so much higher than they should be at the moment. In the lead up to the 2013, Tony Abbott promised to abolish many of the long-term policy mechanisms that the Rudd and Gillard governments had introduced into the energy market, to make business think about climate change when making their investments. Abbott got rid of the carbon price, and unilaterally reduced the renewable energy target (RET) that businesses had been using to make investment decisions about what Australia's energy mix should look like over the coming decades.

Then, when Turnbull seized power, the one thing he refused to do was set a target beyond 2020. (Labor has now swung behind that policy.)

While 2020 might seem like the distant future to politicians in Canberra, people working the numbers at electricity companies laugh at how short the RET's time-frame is. Energy planners make decisions that span decades because the only way to budget these things is to spread the cost of the investment across decades. The more uncertain that future is, the more the budget needs to be padded out to take account of those uncertainties.

The bean-counters inside the energy companies know that the Coalition's policy does not provide realistic guidance for how Australia's energy-mix will look over the long term. Promising a low renewables target doesn't change the reality that renewables will have to become a large part of the energy mix -- it just makes it more uncertain how Australia will get there.

Businesses and banks are pricing in the risk of erratic policy-making. And, as Howard argued in 2004, that, in turn, puts pressure on interest rates.

To fill this vacuum, state governments of all stripes started introducing their own targets to provide local energy operators policy guidance over the longer-term.

But at a Federal level, even though energy companies are wanting guidance and certainty instead they get brain-waves from Mr Ideas Boom himself, Malcolm Turnbull. Ideas like the Snowy Hydro upgrade, which doesn't solve any real long-term supply problems, and instead just highlights just how erratic Federal policy-making has become.

Of course, it doesn't just apply to electricity. In many areas desperate for reform -- from housing to broadband to transport infrastructure to taxation -- there has been a similar pattern. Turnbull allows a policy vacuum to develop and then tries to solve it with a wacky, Latham-esque brain-wave that just adds to the uncertainty. Remember Turnbull's idea that he was going to solve Australia's tax problems by giving the states responsibility for income tax? Boom!

Same with infrastructure. The government's $50 billion infrastructure plan is woefully behind schedule, with not enough announcements to be able to spend the money in time. They modelled their finances for long-term "jobs and growth" around a big flashy dollar number, but have inadequate follow-through on actual plans. All that adds to investment uncertainty.

And this has a long-term inflationary effect that's now starting to become visible. Businesses and banks are pricing in the risk of erratic policy-making. And, as Howard argued in 2004, that, in turn, puts pressure on interest rates.

Interest rates are directly related to expectations around inflation. If things are going to cost more in the future, investors demand higher interest rates to take that into account. If prices are expected to rise 1 percent a year, I might be fine with an interest rate of 3 percent, pocketing a profit of 2 percent. But if prices rise by 5 percent a year, I need to charge 7 percent just to end up with the same profit.

This is why it's no surprise that the banks have announced out-of-cycle rate rises in recent days. The policy vacuum that Turnbull has let develop in the housing sector is a symbol for a wider problem created by the government.

Call it 'The Latham Effect'. In an environment where the fundamental stability of government policy is undermined, the cost of doing business in the country rises, and that impacts on interest rates. And that's exactly what we're witnessing under Turnbull.


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