The idea is simple: I borrow money to finance some clever non-productive scheme designed to make much more money than I borrowed. If I fail then the lender I borrowed from will make a loss. If the lender makes a lot of losses he will have to borrow more money from someone else to stay in business. If there is no one to borrow from in the end we must declare bankruptcy. All the people employed by the various schemes will lose their jobs and join the ranks of the unemployed.
One way to stay in business is to buy debt from big governments – such as the USA – and remain secure in the knowledge that such a government cannot go broke. Indeed they alone have the means to forestall bankruptcy by borrowing more from themselves, i.e. printing more money (also called quantitative easing these days). This will fuel inflation in the long term but in the short term is an easy solution to prop up the financial markets that have engaged in suicidal schemes to make vast profits.
In the meantime the real nuts and bolts economy is starved of credit as well and is unable to invest in R & D, hence regressing to a state of just staying alive by retrenching output and by sacking half the workforce and underpaying the other half. Recession and depression results. Depending how severe it will be, the working classes will be wooed by various political nut cases who promise a quick end to the debacle (e.g. the Tea Party). On the left and anarchic fronts there will be uprisings.
Those governments that hold vast government bonds from potentially defaulting states – as does China vis-à-vis the US – are then left with near worthless assets, thus unable to finance their huge trade surpluses, having to regress to stay afloat in the domestic market – which is still underdeveloped.
If the EU cannot stem the domino effect of the Irish-Portuguese-Greek meltdowns to reach Spain and Italy then all hell will break lose.
Common sense will return when the so-called free markets are strictly regulated to service the productive sectors alone rather than engage in get-rich-quick schemes that flourish at exponential rates in the non-productive sectors - if left to their own devices. Freedom does not mean to be free to ruin the whole world by borrowing vast amounts of capital in order to lose it all in a game of financial poker. If the debt is greater than the world’s resources to cover for it, we are certainly at the beginning of a long dark tunnel as far as the global economy is concerned.
