Step back and look at what is happening across our country. What you will see is not pretty.

The fall in the share prices of Woolworths and Wesfarmers (Coles and Bunnings) over the last few days is the first sign that the market realises that the dramatic events taking place in Canberra are going to hit already sluggish retail spending.

It’s the first whiff that the market understands what is about to take place.

Whether it is a tax levy on middle-income Australia, a cut in welfare or slashing government spending in particular areas, we are going to see measures that will reduce people’s spending power and/or create job uncertainty.

This squeeze on the economy comes just as we are about to lift shift allowances and penalty rates in retail as part of a decision made four years ago which cuts in on July 1 (Australia faces a humiliating retail calamity, November 12). That’s a very nasty retail combination -- higher wages and reduced demand. And what’s happening in retail will spread through the economy.

Right now this underlying problem is being masked by higher house prices -- not generated by real demand via first home buyers but driven by Chinese buying and by a lowering of bank credit standards to allow a big rise in investment house buying on the expectation of higher rents. If the clamps on the Chinese shadow banking system are to be continued for an extended period we are likely to see fallout in the Australian property market (China’s shadow banking squeeze could choke Australia, April 30).

The cocktail of higher retail wages, lower consumer spending, increased job insecurity, a lowering of bank credit standards to foster housing investors, and a Chinese shadow banking squeeze, is a dangerous combination if events. In normal circumstances there would be a further fall in Australian interest rates to boost consumer demand and lower the dollar. But the current low rates, fanned by lower lending standards, are driving money away from bank deposits into investment properties.

In previous tough times we have received a ‘get out of jail free card’ via higher commodity prices, but there is no joy in iron ore, coal or gas prices at the moment. Indeed the price of each of these key export materials is under pressure.

I don’t want to alarm readers but we have a situation where there are a series of decisions being made in government, housing, banking, wages and investment that are at odds with each other.

The government knows that it faces major employment problems with the end of the mining investment boom and the close of auto manufacturing, plus the switch from store-based retail to online retail. Its answer is massive investment in infrastructure. This will help but it takes time to ramp it up and it helps only part of the community.

I am not sure Tony Abbott and Joe Hockey fully understand what is ahead. We will know more when we see the budget.