As the government comes under sustained attack for a punitive budget, its strategists will be desperately hoping its economic and revenue forecasts turn out to be too pessimistic. That would allow it to point to a lower deficit and higher growth as evidence its cuts targeting low and middle-income earners, and the young and the disabled, have started producing results before the next election.

Missing in all the focus on who the government was flogging (and giving handouts to) was the fact that the budget had 2014-15 growth sliding to 2.5%, from the estimated 2.75% this financial year (higher than Treasurer Joe Hockey claimed in the Mid-year Economic and Fiscal Outlook in December), then back to 3% in 2015-16 and 3.5% after that. Unemployment is forecast to go up over 6% next year as well. How the international economy, and in particular China, fares between now and then will be a key factor determining whether that scenario plays out.

We should remind ourselves about what the Reserve Bank said in its latest statement on monetary policy earlier this month about the Chinese economy and specifically the health of China’s steel industry:

“Further slowing in Chinese demand for steel would provide a downside risk to iron ore and coking coal prices, and hence the terms of trade. It could also lead to the closure of some higher-cost Australian coal producers and the cancellation of a number of coal investment projects.

“If the exchange rate was to depreciate with the decline in the terms of trade, there would be some offsetting boost to service and manufactured exports from a lower exchange rate, but any substantial weakening in Chinese steel production could be expected to reduce GDP growth over the forecast period.”

No other single event or factor (barring a GFC-style external crisis), has the capacity to “reduce GDP”. The risks are now significant and they are getting more apparent as our iron ore exports to China boom and boom. Could it be that this is the much looked-for bubble that bears devote so much time to looking for, rather than house prices?

Australia is, to be blunt, hooked on Chinese iron ore demand. Our LNG exports are growing, but nowhere near quickly enough to match iron ore. In the nine months to March this year we exported just over $72.4 billion worth of goods to China — most of it iron ore. That is almost as much as the $77.9 billion we exported in the whole 12 months of 2012-13, and compares to $55 billion in the first nine months of that year. The $22.4 billion jump this year has been the sole factor for return of our trade surplus in the past six months.

The question now for Australia is how long can the Chinese steel mills continue to keep our economy ticking over (and away from the edge of a slowdown). The Chinese are continuing to buy despite a fall in the value of their currency this year and the obvious slowing in demand in China and weakening prices. A sudden slowing in the current record level of iron ore purchases would crunch the economy at its most vulnerable time, especially with government spending also contributing less. With it would go Hockey’s hopes of returning to surplus over the next five years, let alone at a faster rate.

In fact, we would suffer the worst of all worlds — a terms of trade shock coming from sliding prices and demand (meaning lower volumes) for our single most important export (which would also, as the RBA says, flow on to coal, especially coking coal used in steel production). It would drop the value of the Aussie dollar, which might help cushion the blow, but it wouldn’t stop the blow to GDP in the short term (and don’t forget a fall in the value of the dollar would put inflation under pressure, limiting the RBA’s capacity to cut rates).

Fortunately, for the moment there’s no sign of a slump in demand for Australian iron ore. However, the budget expects that “iron ore prices … fall further in 2014-15 and 2015-16, reflecting further growth in global supply and slower growth in demand for steel,” part of a broader weakening of our terms of trade. And world iron ore prices are on the edge of slipping under US$100 a tonne which could come sometime this week after another nasty fall in the mineral’s price on Friday night, our time.

According to the Steel Index, the global price of the benchmark 62% iron oxide iron ore fell to a new 20-month low on Friday night of US$100.70 a tonne. That was the lowest the price had been since September 2012, when prices were recovering from the most recent low point of just under US$87 a tonne. The price fell after bearish signs from the Chinese steel industry and persistent concerns about rising supplies.

And in the Singapore futures market, the price of the same ore in the June contract fell to US$100.65, the lowest in 13 months.

But Chinese steel output in the first four months of the year rose 2.7% on year to 271.86 million tonnes. It’s not as fast as we saw in 2013, but it’s better than many western “experts” forecast. In April, China’s iron ore imports topped the 80 million tonne mark for the second time this year, and imports in the first four months of 2014 were 305.3 million tonnes, up a huge 21% year-on-year.

Both Australia’s immediate economic future, and the hopes of an embattled government, will heavily depend on those Chinese steel mills and their voracious demand for our ore.