China's interest rate move leaves Australia exposed: 'Future is grim'

With great fanfare, the People's Bank of China cut mortgage interest rates this week. Markets screamed with happiness, bidding up iron ore miners.

There's only one problem: the cuts are the equivalent of an ant attacking a Tyrannosaurus Rex. The Chinese economy is in the throes of a full-blown structural adjustment from construction to manufacturing.

This is expressed through two significant economic sectors. On the downside, diminishing quantities of empty apartments and roads to nowhere are built.

On the upside, booming exports of low-carbon technologies like solar panels and electric vehicles fill some of the void. The net result is falling growth, but growth that Beijing likes because it is productive.

Now is the time of shrinkulus

Contrary to popular belief, Beijing does not want the Chinese economy to become a typical Western consumer economy.

Rather, it wants China to be a kind of giant Germany; an export powerhouse that doesn't waste resources on things like empty houses.

It has taken a decade for Xi Jinping to fully express this economic doctrine.

In part, the delay was his consolidation of power. In part, it was convenient to stimulate more wasteful buildings. But now, both have come to an end.

Emperor Xi is untouchable in his Austrian economic castle and the Chinese economy can't handle more debt as asset prices like housing deflate.

So, Beijing is now stimulating only at a pace that keeps intact the underlying structural adjustment. Stimulus has become shrinkulus.

The future is grim

For Australia, it does not take Albert Einstein to work out the implications. China is already using less coal, gas and iron ore. Even less is ahead.

Steel and iron have been falling for years already and they are not even halfway down yet.

This affects the economy in three ways over time.

First, budget receipts are hit, spending is cut, or taxes rise. Second, falling prices force miners to curtail investment. Third, equity prices fall, which has begun but has far still to run.

These three impacts comprise a giant national income shock that wipes out wage growth and inflation.

The Reserve Bank of Australia will be forced to cut the cash rate much deeper than anybody expects through the next few years.

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