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Cormac Lucey predicts another global financial crisis in the next 20 years that will dwarf our current one.

Sometime in the next 20 years, there will be another financial crisis that will put what happened in 2008 and 2009 in the half-penny place. The key factor behind that crisis will be the similar to the current one: an unsustainable build-up of debt and leverage. Only next time, the crisis will centre on an unsustainable build-up of debt in the public rather than the private sector. That will make it immeasurably harder for policy-makers to craft an effective response to the crisis.

If one examines the history of US financial markets for the 19th century, one sees a recurring rhythm of boom and bust. The object of the boom may have been varied- lumber, railways, gold and property - but the pattern was always similar: a real advance triggering increased growth, profits, increased asset values; speculative capital using borrowed money to further push up asset values and a precipitate bust accelerated by bankers calling in their loans at just the wrong time.

There were frequent bank runs as depositors, worried that their banks were overexposed to falling asset prices, sought to withdraw their deposits. In a bank run, even good banks with good loans could be ruined as the withdrawal of short-term deposits forced the precipitate liquidation of long-term loans. After the Panic of 1907, demands for banking reform were acted upon by the US government. The 1913 Federal Reserve Act made the Federal Reserve the central bank of the USA. By determining monetary policy and with the ability to print money, the central bank would be perfectly positioned to act as lender of resort to banks facing a run on deposits. The Federal Reserve would improve the overall performance of the economy by tempering the extremes of boom and bust. In the main, this is what the Fed has done in its near century of existence. By standing as lender of resort, it has reduced the incidence of acute boom-and-bust cycles compared to what went before.

There was one occasion when it failed badly: the crash of 1929 and the subsequent Great Depression. That had devastating effects on the US economy: unemployment rose to 25%, prices dropped by the same amount, there were hundreds of bank failures and equity prices fell by nearly 90% from their peak.

The views of the current chairman of the Fed, Dr Ben Bernanke, on the Great Depression are interesting for he has made it the focus of much of his academic study and the global economy now faces a situation not unlike that of the 1930s.

In a speech he gave on Milton Friedman's 90th birthday, Bernanke seemed to support that monetarist view of the Great Depression. He said: "I would like to say to Milton... regarding the Great Depression. You're right, we did it. We're very sorry but thanks to you, we won't do it again."

The central US strategy for combating our current crisis flows from this analysis. It has featured steep interest-rate cuts, emergency finance for distressed banks and aggressive monetary easing (ie, printing of fresh money). These measures have been the US response to every financial crisis since the second World War.

The problem with this strategy is that while it permits booms, it prevents busts. While it permits a sustained build-up of debt, it prevents a real reduction of debt across the economy. This means that private-sector debt levels have been growing inexorably across the western world since the second World War. They have now approached their limits, as we, in Ireland, know only too well.

All this is in contrast to what happened in the 1800s. Then, booms were followed by busts. Busts featured substantial debt liquidation as debts were repaid, restructured (into equity) or written off. While there was horrendous short-term pain, there was no gradual build-up of debt in the economy with all of its attendant risks. 

But today's highly responsive political systems cannot cope with the deep pain of aggressive deleveraging. So they prefer short-term fixes even if they come at the expense of a gradual and dangerous build-up of systemic risk. That risk is the seemingly unstoppable build-up of debt.

In the UK and the US,private-sector debt levels were 211% and 212% of GDP in 2008. Here in Ireland, debt levels exceeded 250% of GNP in that year. These debt levels have led to enormous financial fragility, broken banking systems and, in housing markets, debt-deflation. Now, governments are intervening. The public sector will help carry the burden of private-sector debt. The US and UK governments have intervened aggressively to rescue their banks. In Ireland, the public sector has, through the bank guarantees, guaranteed the liabilities of Ireland's private-sector banks.

But public sectors across the western world are already heavily indebted. And that's before we lift the carpet to examine their hidden liabilities (unaccrued pension liabilities, systemically growing health expenditures, the long-term financial burdens of public-private partnerships). In Japan, nominal income growth is less than growth in debt service costs ie, new debt must be issued to service old debt. All this is before we consider the possible impact that rising interest rates could have on the capacity of governments to service their debts. The current global financial crisis is bad. The next one will be vicious. 

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