Why the Dollar May Be So Strong
According the UK Telegraph the strength of the US dollar lies not only on the last fall's flight to to "safety" by many investors, but also on a mismatch of borrowing by European banks. In the latter case banks would fund longer term dollar positions with short term local currency transactions. Now with all the turmoil in the markets as their short term positions roll over the banks are trying to move into dollars. I have heard of this before, but this is the first validation of the issue I have seen. If you are interested in the original article it is available at the BIS. Text in bold is my emphasis.
European banks face a US dollar “funding gap” of almost $2 trillion as a result of aggressive expansion around the world and may have difficulties rolling over debts, according to a report by the Bank for International Settlements.
The BIS said European and British banks have relied on an “unstable” source of funding, borrowing in their local currencies to finance “long positions in US dollars”. Much of this has to be rolled over in short-term debt markets.
“The build-up of large net US dollar positions exposed these banks to funding risk, or the risk that their funding positions could not be rolled over,” said the BIS.
The report, entitled “US dollar shortage in global banking”, helps explain why there has been such a frantic scramble for dollars each time the credit crisis takes a turn for the worse. Many investors have been wrong-footed by the powerful rally in the dollar against almost all currencies, except the yen.
British banks had accumulated a dollar "funding gap" of $300bn by mid 2007. The latest BIS data up to the third quarter of 2008 shows that this exposure has been trimmed by “deleveraging” but it still largely hanging over the UK financial institutions.
Swiss banks had a funding gap of $300bn at the onset of the credit crunch, an extremely high figure relative to Swiss GDP. German banks were $300bn short, and Dutch banks were $150bn short. Belgian and French banks were neutral.
The BIS said the total “funding gap” in dollars was around $2.2 trillion at the peak, when money market liabilities are included. This had fallen to around $2 trillion by the time of the Lehman Brothers collapse. The data is collected with a lag but it appears that there are still huge dollar liabilities to be covered.
Simon Derrick, currency chief at the Bank of New York Mellon, said the implications are obvious. “The global bullion of the last eight years was funded on dollar balance sheets, so the capital destruction we’re seeing leaves banks starved for dollars. Dollar is clearly going to appreciate a lot further,” he said.