It has been another bad week for John McCain and another black Friday for Wall Street as the Dow clocked up its worst week in history. Nothing seemed to help; neither the slashing of interest rates, nor the $700 billion bail-out has halted the panic that has spurred the biggest sell-off in US history. A spate of 'reassurances' by US president George W Bush had the opposite effect. His mere appearance in front of a microphone seems guaranteed to precipitate another stock market bungee jump.

As the economy plunges, so too do McCain's ratings. And plunging ratings have in turn triggered plummeting campaign standards and a sense that the flailing McCain campaign is dangerously out of control.

McCain's frustration is understandable. He has, somewhat unfairly, become the electoral scapegoat for the country's economic woes. His second debate with Barack Obama, in the 'town hall' setting that McCain has claimed as his own, saw the Democratic candidate triumph again.

The problem with town hall settings, even those that are antiseptically prepared for television, is they are so unforgiving. They are the equivalent of a fluorescent-lit department store fitting room. There is no armpit-high podium to mask paunches or bad posture. Obama's poise and languor amplified his opponent's awkwardness; McCain's stiffness due to his war injuries and the scars from his battle with cancer – a disfigured jaw that looks as though it is permanently clenched – conspired to make him older and feeble.

But the lack of grace wasn't confined to physical limitations. McCain's contempt for his rival, which was telegraphed in the earlier face-off, spilled over into a sputtering volcano of vitriol. His barely-contained anger culminated with a clenched-teeth reference to Obama as "that one", while jabbing a thumb in his direction. Through a series of angry, meandering allegations, Obama kept his cool, even flashing a disarming smile at his overheated opponent. He emerged as a clear winner – Kennedy to McCain's Nixon.

Obama may be 11 points ahead, but there is no evidence of any euphoria in the Obama camp. They know that if you throw enough mud some of it will stick, and they realise that McCain's attempts to link Obama to Bill Ayers, the 1960s radical and founder of the domestic terrorist group, the Weather Underground, have gained some traction. They also know that, back in 1982, a charismatic black politician called Tom Bradley, who had a double-digit lead over a white opponent in the Los Angeles mayoral race, suffered a shock defeat. When the time came to cast votes, prejudice outweighed judgement.

With McCain trailing in the polls and flailing on televised face-offs, his campaign is ratcheting up a strategy described by a former adviser as follows: "You take the high road, and we'll take the low road and we'll get to the White House before you". In the final stretch to the White House, McCain is seeking to portray Obama as an unknown quantity with an anti-American agenda.

Over the past week, his running mate, Sarah Palin, has been to the fore in this pernicious line of attack. As rabble-rouser in chief, she has been stoking the fires of fear and uncertainty that have gripped the American people with a series of xenophobic attacks tinged with racist undertones.

De-Americanising a political opponent with an arbitrary patriotism test is a vintage Republican strategy. Mike Dukakis's defence of civil liberties was unAmerican. So was Bill Clinton's interest in Moscow. Even John Kerry's war hero credentials were compromised by a deeply suspect fondness for French wine.

The Republican case against Obama is flimsy. But like a bird building a nest, if you can gather enough wisps, split hairs and fluff, eventually you can fashion something that approximates an American traitor. And right now the McCain campaign is one stop short of alleging Obama is a member of a sleeper terrorist cell.

The case against Obama is as follows: until recently, he didn't wear an American flag pin in his lapel; he went to school in Indonesia; he was photographed wearing Muslim clothing (he donned traditional clothing during a visit to Africa; his former pastor is an America-bashing black activist who used the phrase "God Damn America" during a sermon; his wife was ashamed of America until Obama started looking like he had a shot at the White House (a distortion of her remarks has been doing the rounds of right-wing internet sites since February); Obama has received campaign contributions from Palestinian groups; and worst of all, he has been accused of "palling around" with '60s radical Bill Ayers.

If Obama weren't black and if both his parents were born in Kansas, none of this would matter. But he is and it does, and among working-class white Americans, whose savings, jobs and homes have been threatened by recent events, there is a wellspring of anger and resentment that is being tapped by McCain and Palin.

"Who is Barack Obama?" McCain intones ominously while Sarah Palin questions whether Obama is "one of us". At campaign stops they are introduced by local Republicans who deride Barack Hussein Obama, with a menacing emphasis on his middle name, as the Republican ticket nods and smiles.

This election campaign has taken an ugly turn. At recent Republican rallies, members of the crowd have chanted 'terrorist" and "treason" as Palin makes inaccurate and misleading claims about Obama's murky 'unAmerican' activities. The Washington Post reported that, during a Palin rally in Florida on Tuesday, an audience member shouted "Kill him" as Palin accused Obama of "palling around" with Bill Ayers. At another event, Palin supporters jeered and hurled racial slurs at a black sound operator who was working at the event.

Neither McCain nor Palin has attempted to rein in crowds that are becoming increasingly racist. Instead, they pander to them. Obama, according to Palin, is "not a man who sees America like you and I see America".

In its desperate bid for short-term gain, the McCain campaign is ignoring the wider implications of his strategy and repeated calls by moderate Republicans to call off his pit bull running mate. McCain's conciliatory remarks to a crowd in Minnesota on Friday evening – suggesting they needn't be "scared" of Obama after a supporter said she didn't trust him because he was "an Arab"– seemed ineffectual and weak in the face of rising personal hostility towards the Democratic candidate.

The strategy is all the more dangerous given the sobering history of US race relations. Over five years, John F Kennedy, Malcolm X, Dr Martin Luther King and Robert Kennedy were assassinated. Once you've aroused a lynch mob, it's hard to stay in charge.

The deliberate stoking of fear and prejudice by McCain and Palin isn't just unconscionable and ugly, it is a reckless gambit that could give rise to unthinkable consequences.