Europe’s debt crisis continued to roil markets overnight, with Italian bond yields surging through the critical 7% level overnight, as European officials mulled over the possibility of a radical reshaping of the eurozone that would leave it smaller, but more highly integrated.

According to a Reuters report, senior policymakers in Paris, Berlin and Brussels are now discussing the possibility that some countries would leave the eurozone, while the remaining core moves towards deeper economic integration, including on tax and fiscal policy.

Overnight in Berlin on Wednesday, German Chancellor Angela Merkel repeated her call for changes to be made to the laws which govern the European Union, saying the situation was now so unpleasant that a rapid “breakthrough” was needed. “The world is not waiting for Europe,” she added.

Some commentators are now warning that unless the eurozone moves towards a federal system for levying taxes and making transfer payments, the region could suffer a fate similar to the decline and ultimate collapse of the Soviet empire from the 1980s.

They point out that, like the Soviet Union, the eurozone is coming under intense pressure due to economic stagnation. And, they say, just as in the Soviet Union under Mikhail Gorbachev, European leaders have proved too tardy when it comes to dealing with the region’s deep-seated problems. European leaders continue to unveil “decisive” plans for rescuing the euro, just as Gorbachev announced his glasnost and perestroika initiatives.

But time is running out for European leaders. Investors are increasingly worried about Italy’s €1.9 trillion ($US2.6 trillion) debt mountain, which represents 120% of the country’s GDP. Next year, Italy has to borrow enough money to repay more than €300 billion in maturing debt and to cover a budget deficit that is expected to be about €25 billion. There is a growing fear that investors will be unwilling to lend Italy such sums, and that the country will need a bailout from the eurozone’s rescue fund and the International Monetary Fund.

The problem is that the eurozone’s rescue fund is only large enough to cover Italy’s borrowing needs for few months. What’s more, Italy would only be allowed to tap a fraction of the IMF’s total €280 billion in resources. The European Central Bank has been buying Italian bonds but is reluctant to become a lender of last resort to debt-strapped eurozone countries.

Unless strong eurozone countries such as Germany are prepared to countenance massive fiscal transfers, investors will continue to fret about Italy’s massive debt burden.

Meanwhile, France is becoming a victim of the ongoing market turmoil, with the spread between French bonds and German bunds climbing to a record euro-era high of 1.47%, a big increase from 45 basis points a year ago. The wider spread shows that investors are more worried about lending to France than to Germany, and are demanding a higher compensation for the perceived risk.

Investors are worried that French politicians won’t be able to avoid the temptation to make big-spending promises in the lead-up to the French presidential election. There’s also widespread anxiety about the health of the French banks, with their heavy exposures to Italian, Greek and Spanish debts. Investors fret that if the French government is forced to bail out the French banks, the country’s finances will be subject to further strain.

*This article was originally published at Business Spectator