Australia is gripped by a global market vice

Two overseas forces are propping up the Australian dollar amid Wall Street’s turbulence. But market fears of a smaller-scale US recovery may still come home to roost.

Last night’s big fall on Wall Street tells us that 2014 is not going to be a smooth ride. The task of Alan Kohler, Steve Bartholomeusz and myself is to help you understand the trends but from next Monday there will be a small charge to access KGB commentary. You will also gain a subscription to The Australian as part of the deal. I hope you stay with us.

When there is market turbulence – either up or down – follow where the money is going and it will make what is happening just that much clearer.

And so it was in last night’s turbulence. Let me focus on Australia and the United States.

Traditionally, the Australian dollar should have fallen sharply. But although it slipped, it did not slump because there are two enormous forces pumping money into the country.

The first is of course the mining investment boom but the second is the vast amount of Chinese money coming into Australia to buy and develop inner-city property in Sydney, Melbourne and, to a lesser extent, Brisbane.

In Australia, we have to understand that a number of our key property markets have become Chinese property plays and the trends we see will depend on what is happening in China. This is new territory for Australia (Sydney’s property dam is about to burst, January 21; The Middle Kingdom’s Australian frontier, January 6).

But I emphasise that if global markets keep falling, Chinese investment will not stop our dollar from taking its normal course. In addition, the influx of Chinese property money and mining investment will not stop our share market from receiving a battering today.

Indeed, our share market is also being affected by the dangerous trends we are seeing in emerging countries as it becomes clear that the high risk-taking US investment banks have used part of the liquidity that was sloshing around the US to take risks in emerging countries – and those risks are unraveling.

The fear of the possible losses buried deep in US bankers' accounts is one of the reasons why American bonds are moving in exactly the reverse way to what was expected with quantitative easing. The original theory was that as the US started to taper quantitative easing American bond rates would start to rise and there was great fear as to the effect this might have in the US housing market where interest rates are tried to the US bond market.

But fear of what might be ahead in US markets is driving money into US bonds and of course as the bond prices rise (and rates fall), so the movement accelerates – particularly as the latest manufacturing data shows that US recovery is a slow process.

What markets fear domestically is that too many of the US jobs being created are at the lower end of the pay scale and middle-class America is shrinking. That means that middle class consumer spending, which drove the US to many booms, no longer has the same momentum. That does not mean the US is not recovering but it no longer has the same middle-class spending power to drive forward rapidly.

And of course hanging over all Asian markets, and particularly Australia, the apparent slowdown in China. If that slowdown were to develop momentum it would overshadow all other forces.