Europe's banking system short of US dollars

The US dollar has gained against the euro and other major currencies in recent weeks, which has caused the prices of precious metals to retreat slightly. One reason for the greenback's rising value relative to other currencies is that it is becoming increasingly difficult for European banks to borrow US dollars on the market, as major American money market funds continue to withdraw dollars from Europe's banking system, leading again to constraints in credit markets.

Funding for the Spanish and Italian government via US money market funds has almost come to a standstill in recent weeks. Fears are growing among investors that the debt crises faced by smaller countries at the periphery of the eurozone – the likes of Greece, Portugal and Ireland – is spreading to larger economies such as Italy or Spain. This is one of the reasons why US money market funds slashed their investments in both countries from 6.1% in 2009 to only 0.8% in June 2011.

This is a very critical situation for financial markets since the European Central Bank (ECB) has to step in to fill the funding gap. The lack of willingness among investors to buy more European debt was a key reason why the ECB started buying Italian and Spanish government bonds last month. This is nothing more than an open monetisation of outstanding debts to which the ECB has already committed itself in cases such as Greece. To add to the complications, these measures are now being opposed by some in senior German political circles.

Since banks are refusing to lend to each other, the interbank market is again faced with the prospect of a credit crunch. The demand for US dollars is on the rise as European banks have to repay short-term loans. The greenback recently took out technical levels and broke important chart resistance to the upside against the euro, which could lead to a dollar rally and tighten the pressure on those holding short-term dollar debts. Gold and other precious metals came under sales pressure yesterday, though as more and more mainstream media sources are starting to realise, gold is an asset that nobody can print.