There are two offsetting forces impinging on the Australian economy.

The first is the global economic boom, reinforced by home-grown sources of demand such as strong increases in government spending, tax cuts and investment to increase capacity to supply goods and services, particularly exports of commodities. Inflation is rising (globally and in Australia), but so far there has been no round of wage hikes to derail the boom.

Plenty of wage pressure. For example in Victoria, new premier John Brumby is facing wage hike demands from police, nursing staff and school teachers, as organised labour flexes its muscle.

The second force is the “ripples” from the subprime lending fiasco. Headlines from today’s newspapers include: “RAMS share price fleeced”, “Credit worries and Wal-Mart slam US markets”, “Blood as the price of risk rises”, “Jumpy punters depress bourse” and “Dollar dips again on fears”.

The Economist summed up:

In trying to make sense of the sudden panic that gripped credit markets last week, the most apt comparison is with a previous era of computer-driven financial wizardry, excessive borrowing and unexpected correlations in financial markets. Back in 1998 a large hedge fund, Long-Term Capital Management (LTCM), blew up, putting financial markets around the world under so much strain that the American authorities forced Wall Street to rescue it.

Worst case for Australia is a global slump coinciding with a home-grown wage breakout. Nowadays there is an independent central bank to stand firm in the face of wage demands.

Paul Kelly today puts it especially well:

The main policy question for any Rudd government is whether Labor’s recasting of industrial relations towards trade union power is compatible with the Reserve Bank of Australia’s charter of inflation targeting.

Australia’s economic governance now pivots around the Reserve Bank. The bank’s interest rate increases are the decisive anti-inflation weapon in Australia’s institutional armoury. The extent to which this transforms politics and public policy remains under-appreciated.

As Henry said not so long ago:

Given the rush to expand output of energy and minerals to feed the China boom, it is historically unique that Australia has not generated a wage and cost explosion of enormously damaging proportions. The degree of labour market deregulation from the time of the Hawke-Keating government is the major reason for this unique outcome. The particularly helpful aspects in the recent past are the Work Choices legislation of this government and its sensible use of 457 visas to allow a flood of skilled workers at manageable prices.

How long overall labour costs can remain contained is a vital question. Whether a Rudd Labor government can hold the line will be one of the key questions that economists and other economically literate voters will ponder as they prepare to vote in the coming Federal election.

With superb timing, Roy Morgan Research has asked voters what they think. Gary Morgan says:

The latest Roy Morgan qualitative research shows that if a Federal election were held today it would essentially be a referendum on union power and IR.

Wall Street fell again overnight but by a relatively modest 1 point something percent. It seems the ripples are fading, but a crisis of confidence feeds on itself and market participants remain jumpy.

So far the boom force exceeds the bust force. But if wages start to pop in Australia, especially at a time of rising risk and higher prices in credit markets, the bust forces will win.

Read more at  Henry Thornton