We've been here before: the financial markets get jittery, confidence drains away, signs of distress quickly develop into a full-scale bank run. No question: Ireland is facing its Lehman Brothers moment. With money being withdrawn from banks, the idea that the International Monetary Fund and the European Union can conduct leisurely negotiations with the Irish government is a fantasy. The next 24 hours will be vital – and not just for Ireland.

Let's just recap what happened in September 2008 when the US treasury decided to allow Lehmans to go bust. The next month saw mayhem in the markets, ending in co-ordinated packages to rescue tottering banks. Global growth collapsed in the deepest downturn since the second world war.

Ireland's plight has strong echoes of Lehmans in 2008. It is on its uppers; it has made bad decisions; it cannot survive without massive help. On the face of it, Ireland is not systemically important to the global economy and cannot be described as too big to fail. That is the theory. In practice, Ireland is certainly too big to fail. George Osborne knows it. Angela Merkel knows it. The IMF's Dominique Strauss-Kahn knows it. The ramifications of allowing Ireland's stricken banks to suffer would be profound and swift. The UK's loan exposure to Ireland is bigger than any other country; Royal Bank of Scotland and Lloyds, the two part state-owned banks, are between them exposed to £80bn, so Osborne is being somewhat disingenuous when he says Britain's willingness to put money into a bailout is down to being a "good neighbour". A banking collapse in Ireland would be negative for UK trade, UK banks, UK gilts and the pound. If, as looks likely, the government puts £7bn into Ireland as part of an EU rescue and pays its share of any IMF fund, this will not be charity: it will be a hard-nosed business decision to minimise collateral damage to the UK. Money well spent.

For Merkel and other eurozone leaders, the fear is of contagion. In the case of Lehmans, bankruptcy spread through the banking sector. In Ireland's case, it would be to other peripheral eurozone members. Portugal would be the next domino to fall but the real concern is Spain, which, like Ireland, is suffering the after-effects of a bubble in its housing market. Spain has 20% unemployment, rising to 40% for young workers, and is ripe for a fresh downturn. A speculative attack on Spain would put the euro itself at risk.

Strauss-Kahn's concern is simple. The IMF believes the worst of the crisis is over. Emerging economies bounced back quickly from the global recession of 2008-09 and the developed world is now struggling. Up until now, the IMF's feeling has been that Europe's sovereign debt problems are the coda to the old crisis, rather than the overture to a new period of turbulence. That would look a less plausible argument if the collapse of the Irish banking system triggered sovereign debt crises across western Europe and beyond.

So Ireland will be rescued, though the price exacted will be high. No country can expect an easy ride when an IMF mission arrives in town. The Irish will have many years to repent the policy errors, reckless lending and greed that allowed the housing bubble to get out of hand. As in Britain's repeated bouts of property mania, the Irish were seduced by the idea of easy money, pushing aside doubts about who was going to buy all the homes built by a construction sector that ballooned to 15% of the economy.

Fresh austerity measures, while seemingly inevitable, will be pointless. The Irish economy has already shrunk by nearly 20% since 2007, and taking even more demand out of the economy through tax increases and spending cuts would simply extend the downturn to perhaps six years. It will be interesting to see if Dublin can resist pressure from Germany and France to raise Ireland's 12.5% corporation tax, which has been a magnet to attract direct investment into the country. Berlin and Paris need to be careful with this approach. Not only does Ireland need strong export performance to compensate for the squeeze on the domestic economy but there is also a risk of further alienating a disaffected public with a punitive Treaty of Versailles-style peace agreement.

Remember that Versailles proved to be no lasting solution to the underlying problems of the inter-war period. The rise of Germany, the United States, Japan and Russia, together with the decline of Britain, France, Austria-Hungary and the Ottoman empire, had disrupted the stable balance of power that had existed for most of the 19th century. The system was in a state of flux and inherently unstable.

The underlying problem today is the inherent unworkability of the euro. The single currency only works if all its members chug along at much the same rate – with growth, productivity and inflation rates all in synch. If that does not happen, the countries with lower costs and higher productivity run big trade surpluses and countries that have higher costs and lower productivity run big deficits. Over time this leads to big problems in competitiveness that cannot be tackled in the traditional way, through a depreciation of the currency.

The countries on the fringes of the euro are now in this position, and are being told to deflate their economies to align their costs with more successful countries. The only alternative would be for creditor countries to accept higher inflation to accommodate the weaker members of the club. This is not going to happen in the eurozone, where Germany, with its existential fear of inflation, calls the shots. Every country in the euro area plans to tighten fiscal policy next year – an exercise in pointless economic masochism.

It is traditional to say that too much political capital has been invested in the euro for it to collapse. In fact, it is easy to sketch a timetable for its break-up. Voters in peripheral countries decide they have had enough austerity; populist parties reflect those concerns. The core countries say the only alternative is fully fledged political union, with a unified budget and strict rules for the conduct of fiscal policy. This proves to be a hard sell.

As a result, Europe seeks to muddle through, which was the approach of the US government in September 2008. But, as then, the strains in the eurozone are becoming bigger, the bailouts more costly. If Ireland's bailout is botched, the unthinkable will be all too thinkable.