The leaders of the Israeli right and of the settler movement have been wearing their Cheshire Cat grins since the United States announced its pullback from negotiations to extend a limited Israeli moratorium on settlement construction. Israel’s right have taken to vilifying America’s current president with a birther-like enthusiasm and are celebrating what they consider to be another victory against U.S. peace efforts. Settlement construction itself is booming, with over 1600 units having been started in the ten weeks since the partial moratorium expired on September 26 (in truth, the construction never stopped anyway).

The official Israeli government line is more measured, insisting that Israeli-U.S. close coordination and mutual appreciation is just hunky dory. That interpretation is one which U.S. officials have been eager to echo, at least in part one imagines for political reasons. As a depiction of reality, it is something of a stretch.

If anything, these past weeks have been more reminiscent of the prickly times which characterized long periods during Netanyahu’s first term in the late nineties opposing the Clinton administration and working closely with the then Republican-controlled Congress or even the Shamir-Bush senior standoff at the beginning of that decade. In recent weeks Prime Minister Netanyahu publicly set out terms for a U.S. letter of guarantees to Israel, which seemed designed to embarrass the Obama administration. Thus far at least, President Obama and his team have given the Israeli prime minister little cause for considering that there might be a cost for such mischief-making (unlike then President Clinton who effectively cornered Netanyahu in 1998–99).

Nevertheless, this latest round of peace failure should probably be looked at not as a setback, but as a potentially useful, clarifying moment. To be fair the Obama administration did not invent this peace process merry-go-round, it has adhered rather rigidly to the same script that has been failing for over a decade and a half, with only minor changes in nuance. The noteworthy difference this time was in the inability of the diplomatic seamstresses to piece together a face-saving shmata that might have covered up the peace process’s naked redundancy.

Contrary to appearances, the collapse of this latest effort actually strengthens the ability of the Palestinians to shape the next moves and to stamp their imprint on where this now goes. There are still three potential game-changers in the mix: Israel, the United States and the Palestinians. Israel, though, seems ever more intent on postponing and avoiding a moment of choice, and its officials now act in a way that make their own policies the single most proximate cause of their country’s increasing (self)delegitimization.

Netanyahu constantly reminds his American and other interlocutors that his domestic politics on peace, territory and settlements are terribly tricky and that he should not be expected to squander political capital until the real moment of truth arrives. Yet he does everything to make sure that moment will never come, and it appears now to be structurally endemic to the Israeli system that procrastination will invariably prevail and that Israel will not end the occupation of its own volition. Nothing Netanyahu has done in his second term as prime minister suggests otherwise.

The only steps Netanyahu seems willing or able to deliver are in areas decidedly tangential to what it will take to get a two-state solution. Palestinian economic development or improved local governance (areas which he encourages) are as relevant to a one-state outcome or a maintenance of limited Palestinian autonomy as they are to a post-occupation two-state deal.

Netanyahu’s rhetorical embrace of the two-state mantra in a speech at Bar Ilan University last June has not been matched by his actions nor was he challenged to translate this into a formal and binding decision of his Likud movement. We well remember that when the PLO declared it was abandoning terror and recognizing Israel, the demand was made that in order for these steps to be taken seriously they would have to be formally voted on in the institutions of the PLO and its charter would have to be amended (which indeed happened, twice). Not surprisingly but tellingly, no American official (or other official I am aware of) has suggested or requested, let alone demanded, that Netanyahu’s Likud or his cabinet formally endorse the Bar Ilan statement (the formal position of the Likud, last voted on in 2002, remains opposed to a Palestinian state).

What about the United States still producing that game-changing move? This administration prioritized resolving Israel-Palestine and made clear its understanding of the centrality the issue has to American strategic interests and security (a position echoed by the uniformed military, and notably by General Petraeus). However, the approach pursued in the last two years was hardly transformational. They made some very minor tweaks to the flawed process which they had inherited, continuing with essentially the same ingredients—get the parties to negotiate bilaterally, attempt to build confidence while core issues remain unresolved, indulge misbehavior, etc.

To have a realistic chance of success, any U.S, leader would simply have to throw that playbook onto the scrap heap. The United States would have to be willing to present its own formula for a breakthrough, front-loading the territorial and border issue (it’s the occupation, stupid), offer inducements and incentives for progress but make them conditional and not rollover in the face of rejection by either side. America would also need to take a pragmatically inclusive approach to regional and Palestinian realities (Syria and Hamas will need to be part of the equation, even if the latter is via indirect mediation). This not only can, but must be wrapped up together with a package of new security guarantees for Israel and as part of a narrative that articulates why it is not just an Israeli interest but an Israeli necessity. America cannot impose a solution on Israel, but it can dramatically reconfigure the Israeli public and political conversation about the conflict and be the key to unlocking an Israeli political ‘yes.’

If one is looking for an Israeli user-friendly way of getting a breakthrough, it can only be via these options, American or Israeli-driven. But this week’s latest twist seems to make either of these eventualities less likely. The center of gravity is clearly shifting in the direction of a Palestinian game-changing move to break the impasse. That gravitational shift will continue as long as America and Israel pursue more of the same.

Beyond the fleeting headlines and settler glee, the deeper dynamic in play is that the Palestinians won this round even if their current leadership is not quite able or ready to clip that coupon.

Israeli expert on Jewish history Daniel Gavron spelled it out in a Newsweek article in which he described the PA leadership as “the last Zionists”—noting their insistence on the two-state option (even as it vanishes on the ground)—and continuing to play along with fruitless negotiations and to build institutions of statehood where there is no state and no freedom, but only occupation.

Rhetorically, the Palestinian leadership already seems to understand that the momentum and the ability to change the conversation is in their own hands. In recent days President Abbas has spoken of dissolving the PA and of getting UN recognition for a state on the 1967 lines, Prime Minister Fayyad advances an August 2011 deadline for preparing for statehood (and by implication Israeli withdrawal), while other leaders flirt with either the threat or the alternative of pursuing one democratic state with equal rights in all of mandatory Palestine. But they have not yet crossed the Rubicon—for that would entail, among other things, abandoning their deference to American and donor political demands and the daily conveniences and perks of not overtly challenging Israel in the diplomatic-political arena (such as not being imprisoned, prevented from traveling, or not having to go back into exile and also maintaining their PA patronage network—not easy things to kiss goodbye).

That is why, even when Argentina, Brazil and Uruguay recognize a Palestinian state on the 1967 lines—as they did this week at the PLO’s request—it was a largely meaningless act. The recognition did not carry with it actionable items or consequences for Israel, the PLO made no such ask, as they are still playing within the existing peace game rather than strategically shifting the rules of that game.

By contrast, Palestinian civil-society leaders and non-officials have already made that break and are pursuing a popular strategy which puts Palestinian freedom first (whether in a truly independent sovereign state of their own or in one shared state), that pushes for sanctions against Israel for its continued denial of their freedom, and pursues nonviolent struggle and protests in villages across the West Bank.

Making that transition will not be easy for those who the West recognizes as the official Palestinian address and interlocutor. That transition will not happen tomorrow, but it is fast becoming the most-likely game-changer in the foreseeable future. This trend was given a significant shot in the arm by the latest debacle of the rejected moratorium incentives deal and the way it exposed the naked lack of credibility of the existing peace process industry.