Almost two years ago, Dubai's debt woes foreshadowed the spectre of sovereign default. Since then the threat of imminent state insolvency has moved west, to Greece to begin with. Last week the IMF warned that emerging markets face the prospect of "sharp reversals" or even a "sudden stop" if the euro-zone cancer spreads.
Now a global plan is emerging to tackle the sovereign debt crisis before it plunges the world economy back into recession.
Despite public denials, the finance ministers and central bank chiefs of the group of 20 leading economies (G20) appear privately to agree on radical action: a partial Greek default, bank recapitalisation, a firewall to prevent contagion and a fighting fund to impress global markets.
From the outset, the protagonist of the unfolding drama was Greece. True, its economy represents just 2 per cent of the entire euro zone's, but a Greek default would hit European banks holding Greek bonds. That could cause a financial crash and require expensive bailouts.
That's why there was never any genuine alternative to debt restructuring. Ever more austerity would further shrink Greece's national output and raise the real value of its liabilities, making state insolvency and market meltdown more likely.
To break the vicious circle of debt and deflation, the plan envisages an orderly default on half of the country's debt. That means private investors holding Greek bonds, including the banks, will have to take a 50 per cent "haircut". European Banking Authority data shows that European banks hold €98.2 billion (Dh487.3bn) worth of Greece's sovereign debt.
Until recently, banks were not obliged to have capital buffers against their stocks of national bonds, because regulators had given those bonds a zero risk weighting. Substantial markdowns or a default would force banks to raise more capital at a time when investors are fleeing into safe bonds.
Higher capital reserves would also reduce much-needed bank lending to small and medium-sized businesses, and that is the lending upon which growth and jobs depend.
To avoid a second banking crisis, the package foresees another round of recapitalisation.
Banking bailouts first happened in 2008 after the demise of Lehman Brothers, when interbank lending froze and a global "credit crunch" pushed the world economy to the brink of economic apocalypse.
If Greek debt is not restructured, this crisis will spread to other euro-zone members such as Portugal, Ireland, Italy and Spain - dubbed the PIIGS. Not even the combined economic might of Germany and France could rescue them.
European policymakers are desperately trying to build a firewall to protect Italy and Spain from contagion.
Besides bank recapitalisation, greater firepower is needed to buy up Italian and Spanish bonds. That would keep down those governments' borrowing costs and instil market confidence.
At €440 billion currently, the European Financial Stability Facility (EFSF) - a temporary bailout fund - is far too small to rescue Italy or Spain. At the same time, the European Central Bank (ECB) faces growing opposition to its bond-buying programme, that has so far helped Rome and Madrid survive this summer's turmoil.
The plan is for the ECB to underwrite EFSF loans in some sense. Instead of inflating its own balance-sheet, the ECB will provide leverage. That would turn the EFSF's €440 billion into a €2 trillion war chest to defend struggling euro-zone members. All this is aimed at guaranteeing the long-term viability of Europe's common currency.
Taken together, the components of this plan have the potential to avert default and another banking collapse.
But key questions remain. Can Greece escape imminent default? Tomorrow the German parliament will vote on the €440 billion for the EFSF that was agreed by euro-zone leaders in July.
If Chancellor Angela Merkel fails to get a majority, markets will panic. Spiralling borrowing costs could send the PIIGS over the edge. And resistance to taxpayer-funded rescue programmes is even higher in Finland, the Netherlands and Slovakia.
Meanwhile, Greece will need more money just to stay afloat. The next loan tranche of €8 billion is due next month. Should Athens fail to meet the stringent conditions, including large-scale privatisation and draconian spending cuts, the Greek tragedy will end in default.
Nor is it clear whether Greece can survive until the EFSF is replaced by a permanent rescue fund in 2013. Most analysts expect a Greek default late this year or early next year. Only a swift restructuring of the country's debt can pre-empt such a nightmare scenario.
That is why euro-zone leaders will have to hammer out a deal when they meet in late October. They will also need international support at the G20 summit in early November. Europe has about six weeks to save itself and the rest of the world.
But with western countries cash-strapped, where will all the money come from? Last year, the IMF's 187 member states agreed to extend the fund's credit line to about $800 billion (Dh2.9 trillion). But that won't happen until 2012.
Awash with cash, China could step in and provide the IMF with extra loans to support the euro zone. Or, as a global lender of last resort, the Fund might even mutate into a world central bank that commands the respect of international finance.
But where is the political leadership? Will policymakers settle the countless disagreements that could doom the process?
Since the outbreak of the sovereign debt crisis, financial markets have been a few steps ahead of politicians. Now politics can no longer afford to remain behind the curve.
Adrian Pabst is lecturer in politics at Britain's University of Kent and visiting professor at the Institut d'Etudes Politiques de Lille in France
