TSX, Dow plunge into the red

North American stocks markets sold off sharply on Wednesday, unmoved by Italian Prime Minister Silvio Bersluconi's pledge to step down in the midst of Europe's widening debt crisis.

Uncertainty over who will lead Italy next led yields on the country's debt to spike to well above the seven per cent level that eventually forced other eurozone countries to seek bailouts.

The S&P/TSX composite index closed down 332.63 points, or 2.7 per cent, to 12,156.22 points. The Canadian dollar was also sharply lower, losing 1.31 cents US to 97.88 cents US as investors sought the security of the U.S. dollar.

Almost all major currencies were lower against the U.S. dollar. In New York, the Dow Jones industrial average fared even worse, down 389.24 points, or 3.2 per cent, to 11,780.94.

Even gold, traditionally seen as a safe haven during times of uncertainty, lost $7.60, to $1,791.60 US an ounce. "What we're seeing now is the fear that this whole thing is going to become unravelled," ScotiaMcLeod investment advisor Chris Kuflik said.

Debt problems ominous

Markets had initially responded enthusiastically Tuesday afternoon after Berlusconi lost a confidence vote and promised to resign after his government's austerity budget is passed.

Earlier in Asia, sentiment had been boosted by the Berlusconi pledge to resign, with Japan's Nikkei 225 index closing 1.2  per cent higher, South Korea's Kospi added 0.2 per cent and Hong Kong's Hang Seng jumped 1.7 per cent.

But as day broke in Europe and North America, pessimism returned. "The burst of optimism yesterday afternoon on news that Italian PM Berlusconi will resign after the new budget law is passed was short-lived," BMO economist Jennifer Lee said. "Very short-lived."

Investors pushed Italy's 10-year bond rate above the seven per cent level, a level generally seen to be unsustainable in the long run.

'The burst of optimism yesterday ... was short-lived.' —BMO economist Jennifer Lee

The country owes almost $2.7 trillion, and has to finance $300 billion of new debt in 2012 alone. That's the fourth highest debt load in the world, and greater than the debt load of Greece, Spain, Portugal and Ireland put together.

A borrowing rate above seven per cent would be impossible to maintain, given the country's moribund economic growth rate.

When Greece, Ireland and Portugal saw their borrowing rates go that high, the markets concluded they had to be bailed out. For comparison purposes, the rate on a 10-year U.S. government bond was at 1.96 per cent on Wednesday. Canada's sits at 2.07 per cent.

"Regardless of who takes the helm of Italy's new government, he/she will have an equally tough time pushing through needed austerity measures and economic and pension reforms to satisfy both investors and the EU/IMF," BMO economist Sal Guatieri said.

December oil lost 93 cents US to close at $95.74 US a barrel.