The euro zone is staring into the abyss.
Unless European leaders agree on a political remedy for their sovereign debt crisis at a Dec. 9 summit, and the European Central Bank then intervenes massively to support government bonds and European banks, the euro may start to unravel.
Foreign investors are already shunning euro area sovereign bonds, European banks are desperately trying to sell assets including bonds, depositors are withdrawing growing amounts from southern European banks, and interbank lending is freezing up, forcing ever more lenders to turn to the ECB for funds.
Italy, the third largest and most vulnerable euro zone state, has a mountain of debt to refinance from January, and its short-term borrowing rate hit an alarming 8 percent on Friday.
Josef Ackermann, chief executive of Deutsche Bank and chairman of the Institute of International Finance (IIF), the world banking lobby, delivered a stark message to European Council President Herman van Rompuy last week, according to a source familiar with the conversation.
Allowing political indecision to continue into the new year risks a dramatic worsening of the crisis on financial markets, Ackermann warned Van Rompuy and other EU officials.
Major banks such as BNP Paribas and ING announced disposals of sovereign debt this month. The French lender disclosed it had dumped 12.6 billion euros in Italian, Spanish, French and German bonds over four months. The Dutch bank said it had cut Greek, Italian, Irish Portuguese and Spanish sovereign holdings by 5.4 billion euros.
Germany, Europe's creditor-in-chief, has seemed oblivious to distress calls for emergency action and is pursuing a single-minded strategy of changing the European Union's treaty to entrench tougher fiscal discipline.
Chancellor Angela Merkel, determined to prevent countries living beyond their means at German taxpayers' expense, has decided the answer to the crisis is closer fiscal union of the 17 states sharing the euro.
She and her aides are using the raging market turmoil to persuade Berlin's partners into accepting new powers to override the national budgets of euro zone states that go off the rails and if necessary take them to court and punish them.
Under the German plan, European authorities would exercise ultimate control over national debts and deficits, with the right to make parliaments revise budgets that breach EU rules. The Germans are playing the hardest of hardball, said a French official involved in the negotiations.
Countries like France, traditionally attached to national sovereignty, have little alternative but to swallow the German demands for treaty change since their own borrowing costs are rising and Paris' top-notch AAA credit rating is under threat.
President Nicolas Sarkozy, whose hopes of re-election next year effectively hinge on the euro zone crisis, has little to show so far in return for his concessions to Berlin.
Merkel last week publicly doused French hopes of a trade-off in which Germany would give a green light for much bigger ECB bond-buying or agrees to issue common euro zone bonds.
This is not about give and take, she said after they met in Strasbourg last week, insisting she had not changed her position on the central bank, which is that the EU treaty bars it from funding states, or on joint debt issuance.
Germany, haunted by the experience of hyperinflation in 1923 and after World War Two, is deeply fearful of debauching the central bank by printing money to lend to governments.
Bundesbank President Jens Weidmann, a powerful influence on the ECB governing council who speaks for Germany's conservative financial establishment, keeps warning against overstretching the bank's mandate and compromising its independence.
Weidmann, like Merkel, now accepts the principle of jointly issued euro zone bonds as a long-term goal of a fiscal union but only at the end of an integration process that entrenches central control over member states' budgets.
Senior EU and ECB sources, who spoke privately because of the sensitivity of the issue, said there was an understanding that if Europe's political leaders take a big step towards such a fiscal union on Dec. 9, that would give the ECB grounds to intervene more decisively.
Some saw the agreement between Sarkozy and Merkel to refrain from making either positive or negative demands on the ECB as an attempt to clear the way by stifling political pressure.
A deal on moving towards fiscal union is not yet certain, and markets, which hate uncertainty, may well feel the tortuous process of treaty change creates more political risk than it removes.
However, if it gives the ECB a pretext for unleashing its massive financial firepower to defend euro zone government bonds, Europe's desperate politicians may have to embrace it.
One key unknown is whether all 27 EU states will agree to amend the treaty, or whether a separate accord will have to be struck among the 17 euro zone members, or a smaller inner core, cementing an awkward two-speed Europe.
Non-euro Britain may seek to impose its own demands to repatriate control over some social and legal policies, or a veto right on EU financial services legislation, as its price for letting a euro area fiscal union advance.
Several governments are deeply reluctant to start down the avenue of treaty change, either because they oppose ceding more national sovereignty, or because they fear losing parliamentary votes or referendums on the outcome.
Many dread the prospect of long months of ratification roulette, with markets in a frenzy as Europe's fate hinges again on a vote in a small country such as Ireland or Slovakia. The mere announcement of a possible referendum in Greece on its EU/IMF bailout deal caused investor panic and led to the fall of the government.
There is also widespread resentment of increasingly visible German political hegemony in the EU, even in countries such as the Netherlands that share Berlin's priority for fiscal rigour.
Grumbling about a German Europe is growing louder in France, Ireland and across southern Europe. This may fuel popular opposition to painful economic reforms and drain already feeble public support for closer European integration.
But if a promise of fiscal union is the only way to trigger ECB action to pull the euro zone back from the abyss, Europe's political leaders are likely to swallow their misgivings and take the pledge.
(Additional reporting by John O'Donnell in Brussels; writing by Paul Taylor; editing by Keiron Henderson)