I know what it feels like to be the euro. Over the past 48 hours I too have been under siege from Standard & Poor’s. A cascade of downgrade warnings has flowed from S&P’s decision to put pretty much the whole eurozone on credit watch negative.

Curious, unpronouncable entities that I have never even heard of, from the Oesterreichische Entwicklungsbank and the Erdoelbevorratungsverband to the Landwirtschaftliche Rentenbank, have also been put on negative watch following the euro downgrade warning.

The biggest of these consequential credit actions is of course the European Financial Stability Facility. Standard & Poor’s appears to have killed the eurozone’s existing bailout facility, or at least killed its supposed function as euro-bazooka.

The EFSF was meant to be raising trillions, but the potential downgrading by Standard & Poor’s of the remaining eurozone AAA nations raises severe doubts that it could even make the 440bn euros in firepower that it had suggested.

In many ways this is just catching up with the market position. As I reported after last month’s tepid EFSF auction for Ireland (Rest of the World says ‘nein, danke’ to Euro bailout),there was a sharp decrease in funding from outside Europe: less than a third, versus a majoriy at the previous auction.


 
So yesterday’s announcement that the EFSF could be downgraded by two notches by S&P was again remarkable timing, but seems to reflect the fact that the EFSF is being quietly forgotten. Chancellor Merkel did not mention the EFSF in her remarks yesterday in Paris.
 
A senior European source I have spoken to has confirmed that the emphasis is moving towards the early establishment of the European Stability Mechanism. He told me that there had been difficult discussions – “not least because of the change in the economic situation”.

The ESM is the permanent bailout facility. The crucial connection here is between the ESM and the European Central Bank. If the ESM gets a banking licence, it can use its funding to access multiples of that funding with the backing of the ECB’s limitless balance sheet. Then hey presto, Bazooka 2.0.
 
That is what I think is the hidden message of the carefully planned series of speeches from Mario Draghi and Merkozy. Angela Merkel has done a total about-turn on her views from a year ago on punishing fiscal wrong-doers, and burning bondholders a bit.

There’s tacit admission there that the Lehman’s-style experiment with Greece has, so far, brought much more harmful contagion than good punishment of reckless lenders. It feels like a terrible misjudgement.
 
The EFSF was always meant, I think, as a psychological stopgap whilst the permanent European Stability Mechanism was being set up. It was also a way to get round the refusal of the European Central Bank to buy Spanish and Italian government bonds in large quantities.

In order to mimic artificially the unlimited firepower of a central bank, the EFSF was itself a product of financial engineering, which was then subject to a further attempt at financial engineering. Everything rested on on-lending the AAA gold-dust of the six fiscally strong eurozone nations. It doesn’t really work if downgrades actually occur.
 
But then there is the real fun. Mario Draghi’s fiscal compact relies on genuine political change within Europe, more fiscal coordination and coherence, as the price to pay for a more activist ECB. That requires probably some sort of treaty change. If that is signed off by March 2012, then we get tacit thumbs up for the ESM to be levered up to the trillions.
 
Here are some spanners in the works:
 
Bundestag vote on ESM: this is the moment Germany will need come off the fence and choose European solidarity over its aversion to debt/inflation. It might not. It could threaten the coalition.
 
Slovakia/ Finland/ Holland: euro hardcases kick up a fuss.
 
Greek election: due in January/ February; heading for another hung parliament; 16bn euro tranche of troika funding due in March; large coupon payments to be paid in March too.
 
Interaction between Greek electioneering and German ESM vote: highly toxic.
 
Irish referendum on treaty: impossible to see that being passed given austerity misery.