Remove the Austrian judgments about government vs. market and here is what you’ve got:
1. When the euro starts, in essence a bunch of unreliable countries write an irresponsible naked put, pledging that “a euro in a Greek bank is equal in value to a euro in a German bank.” It isn’t. They bust their fiscal futures, though few people see this up front.
2. At first markets believe these pledges and perceive expanded gains from trade, including from lending.
3. Trade and lending across Europe expand, and this includes housing bubbles in some of the countries. Some of this expansion is sustainable, but some of it isn’t. Eventually the parts which are not sustainable become manifest. The PIIGS are not up to the standards they set for themselves and ultimately they can’t credibly make good on those naked puts they wrote.
4. Eventual debt troubles induce (some would say require) fiscal austerity, rightly or wrongly. This brings about the original Prices and Production result that “the consumer demand simply isn’t there to support the new commitments.”
5. More fundamentally, at some point the bank deposits (yikes) are no longer there to see through the new projects and commitments at various local levels. That’s scary.
6. A Hayekian contraction ensues, compounded by Keynesian AD negative shock problems. The imposition of tougher capital standards on the banks, combined with bank attempts to unload the crummy bonds, speeds the downward path.
7. It also becomes revealed that the expansion of the German export sector isn’t quite as permanent as it seemed at the time. Periphery demands for German goods are down and if the eurozone splinters the new “deutschmark” could have quite a high value. Eventually a Hayekian contraction will ensue for Germany as well, although this is just starting.
8. What about the USandA? This is the least certain part of the story, but here goes. The creation of the eurozone financialized Europe to a much greater degree and U.S. borrowers assumed this financialization was permanent, more or less. It isn’t! Our shadow banking system could see a very significant whiplash from all of this turmoil, possibly culminating in (shadow) bank runs over here too. We are trying to gently unwind our shadow banking system connections with Europe but we may not have the time. By the way, trying to unwind those ties just causes Europe to unravel more quickly, so we are like a dog trying to chase our own tail.
And so ends my Austro-Austrian tract.
Addendum: For extra reading, see this recent paper by Claudio Borio and Piti Disyatat, “Global Imbalances and the Financial Crisis,” which is remarkably Austrian (cites Wicksell only, but just look at the names of the sections in the paper). p.15 gives some numbers on why European banks (rather than developing nations such as China) drove a “liquidity glut.” Here is Borio’s overall “macroprudential” framework. Here is Borio’s 2004 paper which more or less predicted the financial crisis, and got some key mechanisms right in a deep ways. Here is an audio interview with him. File Claudio Borio under Underrated Economists.