The relentless plunge of financial markets will lurch into a more dangerous phase that could take the global economy over the brink of disaster tomorrow unless the European Central Bank starts to buy Italian debt.
The eurozone's immensely powerful and independent central bank has not yet clearly signalled it is ready to move to buy up Italy's stressed government bonds amid deep divisions and opposition led by Germany's influential Bundesbank.
As European stock markets racked up their biggest losses for three years on Friday - mirroring the losses in the wake of the 2008 crisis caused by the collapse of the Lehman Brothers bank - Italy's government was forced into rash promises that it might not be able to make.
The alternative to pledging the rapid imposition of bitterly opposed spending cuts, as one Italian minister observed this weekend, was for Italy's government bonds to become as worthless as waste paper when financial markets opened on Monday morning.
"Everyone is afraid our bonds will turn into scrap paper but by returning to a budget balance one year early, the ECB has guaranteed that from Monday it will buy our bonds," said Umberto Bossi, Italy's reform minister....
Both markets and mistrustful ECB governors will be watching the Italian prime minister's progress this week as Italy's MPs, the only parliament to have delayed their holidays, begin to rush through legislation including a controversial change to the country's constitution that will prevent future governments going into the red....
"By making promises from a chaotic Italian government the condition of the action needed to save the euro from debt contagion, the ECB may have created even more instability. Would you want to gamble everything on Berlusconi's word?" said an EU official this weekend.Update
From a column in the Guardian by Julia Finch,
Jean-Claude Trichet, say his fans, has been a supremely successful second president of the European Central Bank....
But Trichet's ECB has also been too slow to respond to the pressures on the peripheral members on the eurozone ... He has risked making a bad situation worse by sticking to his line that countries must start to put their own houses in order before the ECB will intervene by buying their bonds.
It was on this principle, it appeared, that the ECB on Thursday resumed purchases of Irish and Portuguese bonds but left those of Spain andItaly untouched. But on Friday night, as details of frantic telephone conference calls between EU leaders emerged and Silvio Berlusconi announced he was bringing forward his plan to trim €48bn from the budget deficit, it started to look as if Trichet's intransigence may have prompted the very action he has been demanding.
The fires in Rome and Madrid are raging. Trichet's stance so far has been like that of a fire brigade that refuses to send its engines because the occupants contributed to the blaze through their carelessness. The diagnosis of the cause of the fire is spot on, but that does not help to quell flames that are threatening the entire neighbourhood.
This is the problem of "moral hazard" last encountered during the banking crisis. At what point should a central bank intervene for the greater good?
The ECB's answer on Thursday was to extend support for euro-area banks by providing extra liquidity on a six-month basis. A good thing, too – strains on the banking system in southern Europe have been appearing as money seeks safety in Germany.
But it's the sovereign bond market, where Italy and Spain must finance themselves, that is the most visible expression of the crisis. Those 6%-plus yields have terrified investors and undermined business leaders' confidence in hiring new workers and putting cash to work.
Trichet's supporters make two arguments. First, that he has played a deft game, gambling that Italian politicians would be more likely to make the tough budgetary decisions to reduce the country's 120% debt-to-GDP ratio if the ECB took a dim view of their previous efforts.
Second, that the ECB lacks the authority and the balance sheet to buy Italian and Spanish bonds on a scale that would bring a permanent improvement in borrowing costs.
There are stronger counter-arguments. First, Trichet is playing a dangerous game. We know from experience with Greece, Ireland and Portugal that once bond yields pass 6% the plot can become unpredictable. If the ECB continues to stand in the wings, the opportunity to intervene before panic gets out of hand could be lost.
The second – technical – point about the ECB's powers has more merit. But Trichet could at least sound as if he wants more powers.
At the moment, investors know that the European financial stability facility, the current rescue fund, is underpowered and lacks the necessary approvals from member states to intervene in bond markets. The ECB should be filling the gap; it is failing to do so.
Disagreements within the ranks of its governing council don't make the job easy. But neither does Trichet's seeming lack of appetite for a fight.