The commodity slump is just the start of Australia's rude awakening

Persistent declines in commodity prices will see a global reversal of fortunes, and the consequences for Australia will be profound and far-reaching.

The latest oil price fall underlines a dramatic change coming to the world where the impact on Australia will be much greater than we expect. 

For a decade, commodities like oil, coal and iron ore have been king. We have seen a big wealth transfer from developed countries like the US and Europe plus China to commodity-producing regions and countries like the Middle East, Brazil, Russia and Australia.

Now with oil, coal and iron ore falling in price, the wealth is going to go back the other way. The US, Europe and China will be major beneficiaries; the Middle East, Brazil and Australia will have an enormous adjustment to make.

In the Middle East that adjustment will almost certainly come via extreme violence.

Australia may be helped to lessen the pain of its adjustment by the free trade agreements that Trade Minister Andrew Robb has negotiated with Korea, Japan and China. These countries may invest in our agriculture, tourism and health.

But the dramatic global effect of the commodity wealth reversal goes much further.

At the same time as oil, coal and iron ore are falling, we are seeing a new phase of the technology revolution unfold, which will see a fall in the cost of services and goods. That means that we could be set for an extended period of low inflation, possibly accompanied by asset speculation driven by excess liquidity. That would be a lethal cocktail. The lowering of costs will help the profits of many companies.  

Assuming asset speculation is contained, interest rates will stay low in this new environment, provided the Australian dollar does not fall so low that the cost of imports creates inflation with stagnation. 

In Australia we are already seeing the start of the adjustment via the falling dollar and rising unemployment. As mining investment ceases, and Joe Hockey’s motor closure cuts kick in, these trends will accelerate. But the biggest change will be the virtual freezing of wages and salaries at all levels. Only those with powerful bargaining power or who operate in areas where there is considerable wealth creation will enjoy personal income rises.

That means Australians will undertake a broad revision of discretionary spending. Just where Australians will reduce their discretionary spending is yet to be seen, but sporting codes (AFL and cricket attendances are already down), overseas travel and many areas of retail are likely to be early targets.

There was an enormous adverse reaction to the 2014 budget because Treasurer Joe Hockey crafted it badly and Australians had been given no warning of what was ahead in the election campaign.

But Hockey could see the problem. Unfortunately, current and future prime ministers and treasurers are going to have to explain to Australians that the game has changed. There will be deep shock and many areas of the society that rely on government handouts will need to adjust to lower payments. The ABC is merely a forerunner of what is to come.

And the share market will require adjustment. Not the least of these adjustments is that BHP will become a yield stock.

I think the enormous LNG projects that are being constructed will yield very disappointing returns. Santos is already warning of this. The giant Gorgon WA operation, which ranks as one of the worst-managed in our history, will take a very long time to produce taxable income given the low oil price and its bloated capital costs.