Sovereign Debt Crisis, Have We Crossed the Point of No Return?
By: Philipp Bagus
May 21, 2010
A specter is haunting the world, and especially Europe: the specter of a sovereign insolvency. The acute sovereign-debt crisis is largely the result of government interventions in response to the financial crisis.
As Austrian business-cycle theory explains, the credit expansion of the fractional-reserve-banking system had caused an unsustainable boom. At artificially low interest rates, additional investment projects were undertaken even though there was no corresponding increase in real savings.
The investments were simply paid by new paper credit. Many of these investments projects constituted malinvestments that had to be liquidated sooner or later. In the present cycle, these malinvestments occurred mainly in the overextended automotive, housing, and financial sectors.
The liquidation of malinvestments is beneficial in the sense that it purges inefficient projects and realigns the structure of production to consumer preferences. Factors of production that were misused in malinvestments are liberated and transferred to projects that consumers want more urgently to be realized.
Solutions to the Crisis: Diverging Paths