A commodity price slide is developing, and if sustained, it threatens to damage the budget, force the Reserve Bank into more rate cuts in coming months, trigger another terms of trade collapse and damage national income just at a time when the great resource investment boom is ending.

The trigger is the growing financial instability in China and not the problems in Europe with Greece. The latter are a distraction for people who can empathise with beleaguered Europeans but have little grasp of how dependent Australia now is on continuing Chinese prosperity and the implications of the remarkable inability of the Chinese government to take control of the rout that has wiped US$3.2 trillion off the value of the sharemarket in three and a bit weeks.

The Chinese government has cut interest rates, ordered the central bank to lend money to financiers of margin calls credit, cut taxes, limited new floats, eased controls on margin lending, and most stunningly, engineered the mass suspension from trading of more than 900 companies, now over a third of China’s listed companies and over 40% of the sharemarket.

So far none of that has worked; the rest of this week will tell whether the government is able to grab back control, possibly by suspending all trading to prevent the rout from damaging the wider economy. That could be closer than you think after the Shanghai market plunged 7.5% at the opening this morning, dragging down the neighbouring Hong Kong market by a massive 4.6%. It’s becoming increasingly clear that Chinese investors on the mainland believe the government has lost control — which is bad news for the economy and for trading partners like Australia. The falls this morning recall those at the depths of the financial crisis in late 2008.

The damage is already spreading: the market rout has helped trigger a 15% plunge in copper prices in the past three to four days of trading, helped push global oil prices down 12%, bashed gold and silver lower and pushed prices of a range of lesser commodities lower as well. But most importantly for us, the market slide and the continuing weak demand for steel inside China have pushed iron ore prices down 21% in the past nine trading days — including a combined fall of close to 11% on Monday and Tuesday this week. Dopey Australian investors have been ignoring the growing slide in commodity prices — indeed, they pushed the market up almost 2% or 106 points yesterday, ignoring the iron ore fall, the 7% fall in oil and the 10% fall in copper.

The budget forecast is for another 8.5% slide in our terms of trade this year, with iron ore forecast at $48 a tonne (just below this week’s levels) and both coal price forecasts above current levels — though remember the dollar is also forecast to average 77 US cents. So there is room within the budget for some falls in commodity prices, especially if the dollar weakens further, but we appear to have used it up already. It will need a heroic act from the economically inept Abbott government to save the budget and the economy from being badly crunched if the sell-off in commodities is sustained and the Chinese economy is damaged — as well could be the case.

The situation in China has greater implications than merely for the budget and national income: it’s a direct threat to national security in a way that the relentlessly hyped Islamic State (or any other terrorist group) could never be. Australia’s strategic interests rely heavily on a stable, prosperous China that plays a responsible part in international institutions — not just because of all the dirt they buy from us and all the investment that (the Barnaby Joyces of the country not withstanding) we welcome from them, but because our region and interests would be directly threatened by a less stable, more fractious China — perhaps one in which the Communist Party decides to throw the switch to nationalism in order to distract its citizens’ attention from a weakening economy.

Admittedly, Greece hasn’t helped nerves this morning (no action yesterday in the never-ending Hellenic drama was seen as cause for a relief rally among local optimists). The Greek negotiating team (including Prime Minister Alexis Tsipras and his new finance minister) arrived for talks in Brussels with the rest of the eurozone and EU and … presented nothing concrete, exasperating its partners once again. As one of the best commentators on the European crisis, the UK Telegraph’s Ambrose Evans-Pritchard has reported, it does seem that Tsipras and Co simply didn’t expect to win Sunday’s referendum, and are now visibly stumped as to what their options are beyond Grexit.

The EU responded late Tuesday night by giving Greece an ultimatum: the country has until Sunday to reach a new debt agreement, or face bankruptcy and the collapse of its banking system. The leaders of all 28 EU members will meet in Brussels on Sunday night, our time. The Greek sharemarket remains closed, as do the banks (presumably until early next week).

The Reserve Bank merely noted Greece and China in yesterday’s post-meeting statement from Glenn Stevens, after the bank left the cash rate steady on 2%. Like the government, the RBA has been expecting the great slide in our terms of trade — over 27% in the past couple of years — to ease later this year and then stabilise. Indeed the RBA’s Commodity Price Index showed a 2.9% rise in June — one of the strongest rises seen for some months, due to the rise in iron ore, copper and oil prices and the fall in the value of the dollar to a series of new five and six-year lows. While the dollar touched a new six-year low overnight of 73.98 US cents, the new plunge in commodity prices, if sustained, will swamp the benefits from the depreciating currency — cutting national income to even lower levels. An already optimistic budget forecast will be just one casualty among many of the Chinese sharemarket rout.