Nth-best

Good morning and welcome to Detrended, where this week reform is whatever our glorious leaders say it is.

Treasury shows its work

It was a big week for the Albanese government in Australia, as the fallout from last week's budget really came home to roost. Perhaps because of their inability to actually explain their tax "reform" to the public, Treasurer Jim Chalmers was forced to release Treasury modelling showing that shares and start-ups were only swept into the tax grinder because not doing so would make it too easy for property investors – the real target – to get around it.

Ah yes, that old chestnut; a tax system so distorted that governments must pass nth-best policy changes because the existing code, with all of its special-interest carve-outs, has too many holes for clever accountants and lawyers to squeeze through. But rather than actually reform it – say, by switching more of the tax burden from income to consumption – they just whack another layer on top and call it a day.

Not that the government is doing a great job at explaining the method to its madness, which is probably to be expected when the policy is genuinely hard to defend on its own terms. I'd call it amateurish, but it's just too convenient that the only 'features' they reintroduced from the pre-1999 system are the ones that raise revenue, while efficiency-boosting measures like income averaging and loss indexing didn't make the cut.

Don't believe the rhetoric; this is not about fixing distortions in the tax code, intergenerational equity, or "reform". It's about raising revenue because our glorious leaders are incapable of reining in spending.

The term premium returns... or does it

You may have noticed the strong rise in Australian and US bond yields starting to emerge in the chart I posted earlier this week. At one point on Monday, Australian 10-year bond yields hit 5.15% – their highest since July 2011 – before falling back down to a bit above 4.9%.

Yields move inversely to price, so the market is effectively saying government debt just isn't worth as much as it once was. That could be for several reasons; the closure of the Strait of Hormuz, for instance, is close to a textbook supply shock that if prolonged will push headline inflation expectations up. Higher inflation means higher interest rates, and bond yields have to rise to stay competitive.

Going the other way, Thursday's uptick in unemployment to its highest since November 2021 means that in the short-term at least, Australian interest rate expectations have likely cooled.

But none of that explains why even 30-year bond yields have been pushed to multi-decade highs across countries as diverse as Germany, Japan, and the UK. The driver of that spike may well be what's known as the term premium, driven by fiscal credibility concerns. Very few countries have even threatened to stabilise the trajectory of their debt, so investors are rightly asking for more compensation to finance all the spending.

As Hemingway once wrote, the way you go broke is gradually, then suddenly. At some point governments that built their budgets on debt essentially being free may be in store for a rude awakening.

Time to dust off your paper air-plane skills

What does the future of war look like? If the war in Ukraine is any indication it will all be about drones, which are getting more deadly, easier to use, and cheaper by the day. The latest model from Japan is made out of cardboard with a water-resistant coating, carries a 1.3kg payload, is invisible to most radar, and can be built for a couple of grand.

I don't know about you, but if I was in charge of the defence budget for a big, isolated island, I'd be putting considerable resources into this sort of technology. Why would anyone even contemplate invading if you could wipe out a standing army with thousands of cheap, expendable drones? It costs a lot more to raise a soldier than a paper plane!

Have a great rest of your weekend.