Mark Forbes – Wide-eyed youths brandish machetes, armed militias rampage through the streets, terrified civilians flee, soldiers lay siege to police headquarters and your sleep is broken by rifle bursts, heavy machine guns and the thump of grenades. Welcome to East Timor, the world's youngest nation on the brink of becoming its next failed state.

Chaos and violent madness greeted the arrival of Australian commandos in Dili, walking into a country racked with political, military and ethnic divisions. There are no battle lines here, no rules and no certainty military intervention will calm the violence spiralling out of control for the past month.

Australian Defence officials looked shell-shocked after a crisis briefing on arrival at Dili International Airport on Thursday afternoon.

Loyalist soldiers had assaulted police headquarters, killing at least nine and wounding 27 just hours before, with gunfire raking across the heart of the city.

The United Nations, whose compound borders the headquarters, had brokered a deal with defence chief Taur Matan Ruak to disarm the police, but soldiers instead opened fire on the defenceless men being escorted into the UN compound.

Although General Ruak allegedly supports the Australian-led intervention – which was meant to halt the fighting – his troops then launched a major attack against rebel soldiers on Dili's outskirts. Heavy gunfire continued into yesterday morning and more gunfights broke out in town across the day, despite Australian troops patrolling nearby.

Australian officials, led by deputy military chief Ken Gillespie, had to skirt the fringes of the fighting on Thursday night to visit the home of President Xanana Gusmao, then paid separate calls on Prime Minister Mari Alkatiri and Ruak to finalise the terms of the intervention.

In theory all backed the deployment of more than 1000 Australian troops, but gaping cracks are emerging behind the scenes. Gusmao has taken control of the military, a move Alkatiri claims is unconstitutional. Alkatiri says a conspiracy continues to stage a "constitutional coup" against him.

Like his nation, Gusmao, the hero of Timor's independence struggle, is almost crippled – by a bad back. He had to be half carried by two bodyguards into a meeting on Wednesday with the Australian ambassador and the UN to plea for international intervention. Dili's hospital chief was called in to deliver painkilling injections.

Inside, Gusmao exploded before the startled diplomats over the defection of half the police force that morning. "This is your fault," he is believed to have shouted. Some claim the outburst was directed at Alkatiri, others that the police commissioner was the target.

Authorities had lost control, he told the gathering, and only the return of Australian forces could save his country.

The acrimony between Alkatiri, one of those who sought refuge in Mozambique during the independence struggle, and Gusmao, who stayed to fight, is long-standing. It was Gusmao who said Alkatiri erred in sacking 595 striking soldiers, nearly half the army, last month.

Believing they had their President's support, the soldiers staged a demonstration in the capital on April 28. Loyalist troops opened fire, killing at least four people. The shootings prompted the defection of military police commander Alfredo Reinaldo, who took with him about 20 men and many heavy weapons.

Both Reinaldo and Gastao Salsinha – the leader of the original strikers – are charismatic but erratic figures whose goals and grievances are unclear. Salsinha's troops come from the west of Timor, largely younger soldiers resentful of favoured treatment towards the older, veteran independence fighters from the east.

Many gripes are minor; they have been posted across the island without the time or money to visit homes and families. Some claim discrimination, including Salsinha. He was passed over for promotion and a trip to the US after being caught smuggling sandalwood.

The rebel numbers are swelled by those bored by serving in a conventional army with no clear tasks, left to stew in the barracks far away from home.

Reinaldo says he deserted to support and protect "all westerners. Because, on the day, on the 28th, it was easterners who shot westerners. I am witness to that. I do not want to be a part of the (army) that shot westerners".

Alkatiri was behind the "criminal" shooting of civilians at the April 28 demonstration, he says. "Who gave the order? The Prime Minister gave the order."

Reinaldo, whose men were involved in most of the heavy fighting around Dili over the past five days, including a full-scale assault on Ruak's home as Gusmao made his plea for international assistance, claims he is no rebel. "I still respect my institution of the FFDTL (army), so my fellow police officers still respect the institution FFDTL.

"But we are not taking order from any Government member, but we are still bound to the President and (Foreign Minister Jose) Ramos Horta."

Gusmao and Ramos Horta, his key ally, blame Alkatiri for failing to address the emerging crisis within the military. Ramos Horta told The Age the dispute could have been headed off months before if relatively minor grievances and palpable structural problems were addressed. A series of presidential recommendations to reform the force were ignored, they say.

Despite being re-endorsed by the ruling Fretilin Party last week, distrust of Alkatiri, a Muslim leader in a Catholic nation, abounds. His aggressive persona has put many offside, including Canberra during hardball negotiations over dividing the riches of the Timor Sea's gas and oil.

Some believe that Gusmao may soon move to dissolve the Government and sack Alkatiri, using the President's constitutional powers. Rumours persist that he may also remove Ruak.

Suspicions remain over the first confrontation between Ruak's and Reinaldo's men after Government soldiers approached the rebel camp on Tuesday, a battle that scuttled a peace deal being constructed by Horta.

Gusmao was to preside over final negotiations with rebel leaders the next day, aiming to address the soldiers' grievances and proposing a fundamental restructure of the military - devoting troops to either an international peacekeeping task or national civil works.

Instead, a bedridden Gusmao witnessed the total disintegration of law and order as battles between the factions escalated and civilian police joined Reinaldo's men.

With the defection of many civilian police came anarchy on the streets. Gangs, largely made up of easterners carrying machetes, slingshots and spears were out for revenge, attacking properties of westerners they claim supported the rebels.

Heavily armed soldiers sped from outbreak to outbreak, firing wildly to disperse the mobs. The gangs would retreat momentarily, then reform. They burnt down the house of the deputy police commissioner, who had defected to the rebel side.

Also torched was a home belonging to the family of Interior Minister Rogerio Lobato. Six charred bodies were found inside yesterday, including five children. It was "the saddest day in the history of East Timor", said an emotional US ambassador Joseph Rees.

With the body count from the past 48 hours approaching 20 – with rumours of many more – the challenge for Australian forces will be to halt the escalating spirals of revenge. The east/west divide grows with each casualty, splitting the military, police and threatening to spread across the community – gangs were yesterday blockading at least two refugee camps with up to 10,000 people inside.

Ramos Horta – who has been tirelessly travelling across the country, meeting troops and rebels to forge a peace deal – remains hopeful after the Australians' arrival, but admits the seriousness of the challenge.

He told The Age yesterday that some army members had distributed military weapons to new easterner militias, in a chilling echo of Indonesia's support for violent, anti-independence militias in 1999.

"There have been elements that gave weapons to civilians, in the most irresponsible manner," he says. "This is very dangerous, disarming them is difficult."

An order would be issued that "every single weapon in the hands of individuals must be handed in (to the Australian forces)", he says.

The army had been ordered to return to its barracks and stay there, he says. "That will eliminate one of the sources of the problems." Ramos Horta concedes Government troops launched attacks on Thursday night, but says "the Australian forces have arrived and these orders are given clearly by commander Ruak and others. I believe they will start pulling back and stop fighting".

The rebel leaders would also be asked to return their troops to their home villages, he says. "Reinaldo, once we have resumed dialogue, he is ready to surrender his weapons and so are the others."

The emergence of militia groups, along with criminal elements allegedly encouraged by senior Timorese figures who believe they have been disenfranchised by the Alkatiri Government, complicates the picture.

Part of last week's move to unseat Alkatiri came from demoted politicians and crony supporters. There is a battle for the meagre spoils of Timor's economy, beset by the withdrawal of the thousands of people and dollars pumped in under UN administration following the independence vote.

The Government remains the only significant provider and unemployment is rampant. Only the intense gunfire of the past two days removed the hundreds of youths who line Dili's streets pleading to sell newspapers or phone cards to earn a few extra cents. That a minor industrial dispute inside the military threatens to cripple Timor underlines the fragility of the newborn nation and the paucity of its governance structures. Even if the fractured police and military can be united – and that is a big if – any minor crisis could again destabilise the nation.

Insiders say Australia is looking at a long-term commitment, with fears that jockeying for position for upcoming elections, due in under a year, could spark further unrest.

The Australian force must also deal with a cargo cult mentality, locals (who are already calling them Interfet, the name of the post-independence intervention force), believe they will take charge of the nation itself.

Foreign Minister Alexander Downer is already attempting to dampen expectations. "We would be very cautious about offering advice, particularly in how they resolve the problem with the former soldiers," he says. "They are going to have to work that out themselves. We can create a stable environment there for them so they can start to work these things through, and I have no illusions that it will be actually quite hard to work all this through."

Prime Minister John Howard issued a sterner warning to the leadership, stating there "was no point in beating about the bush".

"The country has not been well-governed and I do hope the sobering experience for those in elected positions of having to call in help from outside will induce the appropriate behaviour inside the country," he said. "They do have responsibilities."

However, the sight of Australian soldiers securing Dili centre yesterday demonstrated on whose shoulders responsibility for staving off a state failure will fall. From the hills overlooking Dili, Reinaldo has vowed not to attack the international troops. "We are happy to shake hands," he told the ABC on Thursday. "Tell the Australian troops, don't forget to bring some VB for us."

The jocular tone was less evident in Dili yesterday, as Reinaldo's men fired down on loyalist forces below.

Rise of a rebellion

• March 2 - 600 East Timorese soldiers strike over work conditions.
• April 28 - Rioting by soldiers from the west leaves two dead, 29 hurt.
• April 30 - Hundreds of sacked soldiers flee into mountains.
• May 3 - Australia seeks extension of United Nations mandate.
• May 11 - Foreign Minister Jose Ramos Horta says soldiers will talk.
• May 12 - Australia sends 2 warships.
• May 15 - Australian troops arrive to protect Australian interests.
• May 19 - Fretilin party endorses Prime Minister Mari Alkatiri.
• May 20 - Fourth anniversary of independence.
• May 22 - Peace deal brokered.
• May 23 - Australian troops on standby as fighting erupts again.
• May 24 - The fledgling nation's leaders call for assistance.
• May 25 - More than 1000 Australian troops begin arriving in Dili as part of a military-led intervention.
• May 26 - Evacuations to Australia of expats, East Timorese, Canadians, Indonesians, a New Zealander and a Portuguese begin as heavy fighting around Dili is reported.