It was Wednesday, the day after the political fate of Italian Prime Minister Silvio Berlusconi appeared to have been sealed, and people were astonished - and deeply concerned. Many had felt that the financial markets would cheer the approaching departure of the Italian premier. But they were sadly mistaken. Instead of declining, the interest rates Italy must pay for new sovereign bonds rose sharply on the day after Berlusconi announced he would soon resign. Yields on 10-year bonds were intermittently as high as 7.45 percent. Portugal and Ireland turned to the bailout fund for assistance when their bonds reached that level in 2010.

Even after the announced departure of Il Cavaliere, Italy - it became clear this week - remains the biggest threat to the euro zone. The question of whether the currency area will survive hinges on the country, the euro zone's third-largest economy. Italy's debts exceed 1.9 trillion euros ($2.58 trillion), which is 120 percent of the country's annual economic output. Only in Greece is the debt-to-GDP ratio higher.

Short-term spikes in bond interest rates, of course, are not a huge problem. But should investors continue to demand record returns, the Italian budget will face tremendous burdens. Next year alone, Italy will have to refinance 300 billion euros in maturing bonds. Furthermore, the Italian economy is also sluggish and expected to grow by only 0.5 percent this year. By comparison, the German economy is expected to end 2011 with 3 percent growth.

Italy's economic and debt problems remain real. Rome's progress toward solving those problems is crucial for the survival of the European common currency.

The county, once a leading industrial hub in the US Deep South, filed for bankruptcy court protection after failing to reach final agreement on terms of a preliminary deal with creditors led by JPMorgan Chase & Co in September to settle $3.14 billion in sewer-system debt. Federal Judge Thomas Bennett in Birmingham set a December 15 deadline on Thursday for a hearing on whether the county is eligible to file for Chapter 9, the section of the US Bankruptcy Code that covers municipal bankruptcies.

In another key hearing, set for November 21, Bennett will rule on an emergency motion from John Young, a receiver appointed by the Jefferson County Circuit Court to manage the sewer system on behalf of creditors, for relief from an automatic stay in order to try to keep his control over the sewer system.

"It's critical to the reorganization efforts of Jefferson County that the bankruptcy court keeps the automatic stay in place and affirms the county's rights to set rates, gain control of the sewer revenues and control of the sewer system," said Kenneth Klee, a bankruptcy expert whose law firm, Klee, Tuchin, Bogdanoff & Stern LLP, is representing the county.

For the roughly 660,000 residents of Jefferson County, which includes Birmingham, the state's largest city, bankruptcy means a threat to essential jobs and services. More immediately, it could also mean steep sewer system rate hikes, an added burden on poor people already saddled with some of the highest rates in the country.

But meaningful restrictive measures are not likely to happen, say many analysts, considering China's close relationship with Iran, in part to satisfy China's great thirst for oil. Today, Chinese and Russian diplomats announced that they believe no new sanctions on Iran are necessary.

"The Chinese-Iranian relationship has, in fact, been deepening over the last few years," notes Michael Singh, a former senior director for Middle East affairs at the National Security Council during the Bush administration. The Chinese government not only dilutes the sanctions in the United Nations Security Council by sort of providing Iran with diplomatic cover, but it doesn't enforce the sanctions it even does agree to in the Security Council."

China is Iran's largest trading partner, and this year alone business between the two is estimated at $40 billion, enough of an incentive, say analysts, to block any meaningful Security Council action. Some in Congress are calling on the Obama administration to try and do more.

"What China's doing, as I understand, it is avoiding the kind of economic squeeze we want to put on Iran that could force it not to go forward on nuclear weapons and that's a disgrace and we ought to be much tougher with China than we've been," New York Democratic Senator Charles Schumer told Fox News.

The International Atomic Energy Agency says the "very low levels of iodine-131 have been measured in the atmosphere over the Czech Republic" and elsewhere on the continent. Its statement on Friday said the current levels do not seem to pose a public health risk.

IAEA says the cause is not known, but it is not the result of Japan's Fukushima Daiichi nuclear disaster, which spread radiation across the globe in March. The agency says the radioisotope will lose much of its radiation in about eight days and that the agency is investigating.

This morning the interest rate - the yield - on one year loans to the Italian government rose from 6.4% to 6.63%, and there was a rather smaller rise to 6.79% in the rate on 10-year loans or bonds (before a slight retreat back to 6.76%). These are (again) euro era highs for these implicit interest rates - very worrying for a government with more than 1.8 trillion euros of debt.

What this means is that the cost for Italy of borrowing is becoming dangerously close to the 7% threshold, which the precedent of Ireland, Portugal and Greece suggests would mean that Italy would be unable to avoid an official rescue. To put it in simple terms, if Italy had to pay an average interest rate of 7% on the whole of its debt - which would only happen over years, since it borrows at fixed rates for fixed periods - that would add a crippling 70 billion euros to its annual interest bill.

The subtler, more important point, is that when the implicit interest rate rises to that kind of level, investors know that a country with big debts can't afford to repay what it owes, so they stop lending to said country, they go on strike. No one wants to lend to a country when that country would use the loan to pay the interest on previous loans - that's throwing good money after bad.

To state the obvious, a lenders' strike would be lethal for a country like Italy, which has to borrow 362 billion euros next year (according to Bloomberg data) simply to pay interest and existing debts falling due.

Little wonder that for years now France and Germany have got into the habit of hatching pre-summit meetings, to try to agree it all in advance. But as the sovereign debt crisis has intensified, a problem has emerged. Germany is strong, France relatively weak, and often they agree about almost nothing. So in the past few weeks a kind of politburo has emerged.

Chancellor Angela Merkel and President Nicolas Sarkozy have been joined by one other democratically elected leader - Jean-Claude Juncker, the Prime Minister of Luxembourg, who also happens to chair meetings of eurozone finance ministers. Also at the table are five others chosen by their peers: Jose Manuel Barroso and Ollie Rehn from the European Commission; Herman Van Rompuy from the European Council; Mario Draghi, the new president of the European Central Bank; and all the way from Washington (but really from France) Christine Lagarde, the head of the IMF.

President Sarkozy, for example, spoke this week of a much more clearly defined two-speed Europe, with federalism and total integration at its heart. But Mr Barroso, president of the European Commission, was quick to reply. A split union, he said, will not work. Neither a union with an integrated core but a disengaged periphery; nor a union dominated by an unhealthy balance of power. What is clear is that a very different European Union will emerge from the sovereign debt crisis.

A technocrat government possibly led by former EU commissioner Mario Monti is being debated. On Thursday, Italy raised 5 billion euros (4.3 billion pounds) from new government bonds. But this was at an interest rate of 6.087% to borrow the money for one year. The senate voted by 156 to 12 in favour of the austerity package. The bill now goes to the lower house, the chamber of deputies, which will meet in special session at the weekend.

Alan Johnston, BBC News, Rome, writes:- "All that Mario Monti has said publicly is that there is a great deal to do and there has to be an end to privilege - a reference, really, to the way the political class here is seen as getting too big a share of the national cake.

The idea that politicians will have a lot of their benefits squeezed will play very well publicly, but Italy's problems go deeper than that. Everyone agrees the economy needs to be reformed, but the big question is how. If there is to be austerity, who should feel the pain most?

In the street, they would tell you it needs to be the rich: the financiers, the bankers, the tax-evaders. On the other side of the debate, there are people who would say the public sector workers have had it too easy for too long - that employers must be allowed to hire and fire people more easily if business is to be given a freer hand."

However, there were also reports that German and French officials were privately looking at ways to make it possible for European nations to leave the eurozone, causing US shares to slump by three per cent last night. The turmoil dramatically increased the risk of a "double dip" recession in Britain, with most economists predicting that the economy will grind to a halt before the end of the year.

David Cameron described the state of the Italian economy as "tragic" and urged European leaders to intervene quickly in the situation to stop the crisis spreading to Spain and France. "If you don't have credibility about your plans to deal with your debts and deal with your deficits, whether you like the markets or not, they won't lend you any money," he said. "That's what we are seeing in countries like Greece, and now tragically Italy, where the price of borrowing money is getting to a totally unsustainable level. It's a lesson for all of us to have sustainable plans to get on top of our debt and our deficits."

Jennifer McKeown, a senior European economist at Capital Economics, said: "It is a panic. Rome is burning. Governments need to stop the fire spreading. Britain can't escape the implications of this crisis." Marc Ostwald, an economic strategist at Monument Securities, added: "This is a form of meltdown. I would imagine the telephones between international finance ministries and central banks are in danger of running so hot they'll melt down themselves."

Alistair Darling, the former chancellor, said: "I despair of the way in which EU leaders are constantly behind events. I do not think enough people realise how serious this crisis is, and how hard it is going to hit us. This is far worse than the banking crisis of 2008."

Italian 10-year bond yields shot above the 7 percent level that is widely deemed unsustainable, reflecting investors' concerns that they may not get their money back and prompting German Chancellor Angela Merkel to issue a call to arms.

"That will mean more Europe, not less Europe,'' she told a conference in Berlin. She called for changes in EU treaties after French President Nicolas Sarkozy advocated a two-speed Europe in which euro zone countries accelerate and deepen integration while an expanding group outside the currency bloc stayed more loosely connected - a signal that some members may have to quit the euro if the entire structure is not to crumble.

Merkel Calls for 'Breakthrough to a New Europe'. "It is time for a breakthrough to a new Europe,'' Merkel said. "A community that says, regardless of what happens in the rest of the world, that it can never again change its ground rules, that community simply can't survive."

"This will unravel everything our forebears have painstakingly built up and repudiate all that they stood for in the past sixty years," one EU diplomat told Reuters. "This is not about a two-speed Europe, we already have that. This will redraw the map geopolitically and give rise to new tensions. It could truly be the end of Europe as we know it."

"France and Germany have had intense consultations on this issue over the last months, at all levels," a senior EU official in Brussels told Reuters, speaking on condition of anonymity because of the sensitivity of the discussions. "We need to move very cautiously, but the truth is that we need to establish exactly the list of those who don't want to be part of the club and those who simply cannot be part. In doing this exercise, we will be very serious on the criteria that will be used as a benchmark to integrate and share our economic policies."

It came after spending about six hours over two days meeting with its lawyers to discuss legal options. Those options included a Chapter 9 bankruptcy filing and a settlement with creditors on the county's $3.14 billion sewer debt.

Jefferson County has been trying since 2008 to avoid filing bankruptcy over the debt, which resulted from a mix of outdated sewer pipes, the lagging economy, court rulings and public corruption. At the same time, it faces a separate shortfall of as much as $50 million in its operating budget because courts struck down a major local tax as unconstitutional.

Commissioner Jimmie Stephens made the motion to file for bankruptcy. He said the commission and creditors never could complete the tentative agreement they reached in September and remained about $140 million apart. "Despite our best efforts the negotiations had not produced any decision that fairly treats the county and our citizens. And it did not appear that further negotiations would produce that," he said.

The September agreement called for $1 billion in concessions from creditors and sewer rate increases of up to 8.2 percent a year. He said that without more concessions, the rates would have had to be above 8.2 percent. He said filing the largest municipal bankruptcy ever will create an initial shock, but it will be good to start resolving a financial problem that has hindered the county for too long. "Jefferson County has, in effect, been in bankruptcy for three years," he said.

The measure for pain in this latest market drama has been the yield on Italian bonds, which traded above 7 percent for the first time Wednesday, a level viewed as unsustainable by the markets and the level at which Greece, Ireland and Portugal sought help. The warning signs were also flashing when the yield curve inverted, and 2-year yields rose above the 10-year, which was at 7.25 percent.

Italian Prime Minister Silvio Berlusconi said Tuesday that he would resign after the 2012 budget is approved, which sent risk markets rallying. However, the lack of clarity around Berlusconi's exit concerned markets and Italian bonds continued to feel pressure.

"This is getting to be a game changer, will we have a euro one day? The market is forcing that issue much faster than any time in the past. It was one thing when it was about Greece. If you let Italy go off the cliff, you're questioning why do you have a euro in the first place," said Nomura Americas Treasury strategist George Goncalves. "You cannot allow the Italian bond market, the third largest market, the biggest in Europe, to trade like a high-yield market," he said of the $2.2 trillion Italian debt market.

"The authorities should understand the gravity of the situation. If they don't, then they are admitting defeat and the euro will be called into question," said Goncalves.

The CBOE Volatility Index, widely considered the best gauge of fear in the market, surged more than 30 percent to close above 36.

Stocks slumped further after the Greek President called for a meeting of political leaders on Thursday after the nation's two main political parties failed to agree on who will lead the country's interim government. Earlier, Reuters reported that Greek party leaders had agreed on house speaker Filippos Petsalnikos to head Greece's new coalition government, but the decision may have been withdrawn.

In addition, EU officials said they have no plans in place for a financial rescue of Italy, and adding the euro zone was not even considering extending a precautionary credit line to Rome. "The problem is, we've reached the domino phase, so it's not about Greece anymore - it's Italy and if Italy has a problem, then France has a problem too," said Brian Battle, vice president of trading at Performance Trust Capital Partners. "The hope that there would be a solution is now non-existent."

Italian borrowing costs reached a breaking point, closed over 7 percent, a level that previously drove other euro zone nations such as Greece and Portugal out of credit markets and forced those countries to seek bailouts from external assistance from the EU and IMF. However, most strategists worry that Italy is too large to bail out.

The International Atomic Energy Agency found that Iran is developing a nuclear test facility, nuclear detonators and computer modelling for a nuclear warhead that would fit on an existing missile. Sources say the understanding at the top of the British Government is that Israel will attempt to strike against the nuclear sites 'sooner rather than later' - with logistical support from the US.

A senior Foreign Office figure has revealed that ministers have been told to expect Israeli military action, adding: 'We're expecting something as early as Christmas, or very early in the new year.' Officials believe President Barack Obama would have to support the Israelis or risk losing vital Jewish-American support in the next presidential election.

In recent weeks, Ministry of Defence sources confirmed that contingency plans have been drawn up in the event that the UK decided to support military action. But the source ruled out direct British support, adding: 'Of course we are not in favour of Iran developing a bomb - but do we think they'd use it: no. The bigger concern is it will be impossible to stop Saudi Arabia and Turkey from developing their own weapons.'

Earlier, outgoing PM George Papandreou confirmed his socialist party and conservatives would join the coalition - but he did not name a successor. He said the new government would approve the terms of an EU bailout. Without the bailout, Greece risks bankruptcy and an exit from the eurozone.

Under the terms of the deal, Greece must enact further austerity measures in return for a bailout of 130 billion euros (111 billion pounds; $178 billion) and a write-off of half the Greek debt held by private lenders. The BBC's Mark Lowen in Athens says there is now a perilous power vacuum in Greece, which is running out of time to resolve its problems.

EU economic affairs commissioner Olli Rehn said he wanted the heads of Greece's two main parties to commit in writing to the terms of the bailouts before Athens could receive the next instalment. But Mr Samaras balked at the idea, saying he regarded the rescue deal as "inevitable" but saw no need for a written pledge. Greece needs the next tranche from the first bailout, worth 8 billion euros (6.8 billion pounds; $11 billion), to avoid running out of money within weeks.

One can only guess what is happening in the great global centres of power, but it would not surprise me if US President Barack Obama and China's Hu Jintao start to intervene very soon, in unison and with massive diplomatic force. One can imagine joint telephone calls to Chancellor Angela Merkel more or less ordering her country to face up to the implications of the monetary union that Germany itself created and ran (badly).

Having followed the German political scene closely for the last five months, it is clear to me that almost the entire German political establishment is out of its depth, ideological, sometimes smug, apt to view the EMU debt-crisis as a Calvinist morality tale, and lacking in deep understanding of what it has got itself into. One can understand German worries about money printing - and especially the loss of fiscal sovereignty and democratic control - but matters have already moved on. It is too late for that.

As for the EU authorities with their mad contractionary fiscal and monetary policies in an accelerating slump, they seem to have achieved little by toppling two elected governments in one week. In Italy they have already made matters worse. I doubt that much will change with "technocratic governments" in either Greece and Italy, yet immense damage has been done to democratic accountability. THE EU PROJECT HAS BECOME BOTH DANGEROUS AND INSANE.