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European Banks Go Crazy For The Greenback

We knew there was a drought of U.S. dollars in Europe, but we didn't know they were this thirsty.

The European Central Bank says that banks all over Europe are taking advantage of that money swap we reported on last week. As you may recall, a bunch of central banks got together and made it easier to get loans in foreign currency. Translation: Here are all the dollars you can grab.

The ECB now says that banks in Europe borrowed more than 50 billion dollars as soon as the window was open.

This was higher than anyone predicted. And it called to mind a question we kept asking around the office last week — why would banks, filled with piles of euros, need all those dollars?

We asked this to Barry Eichengreen at the University of California Berkeley. He wrote the terrific book on the subject, Exorbitant Privilege. Eichengreen says that the Euro was designed to take the place of the U.S. dollar in international trade, but it never worked out that way.

"The peculiar fact of the matter is that banks in Europe do a lot of their business in dollars," Eichengreen says. "And that's part of the reason Europe is having so much trouble now financing their economies."

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It goes back to the dream of the Euro. When European leaders reduced all the barriers between the countries of Europe, they also gave their banks free reign to move massive amounts of money around the world. It's hard to believe, but banks in Europe had looser rules than the banks in the United States. European banks were allowed to use much more borrowed money to make their investments. This was meant as a way to make sure that the new Euro would become a major world currency, but it also worked the other way around.

Banks in Europe bought up tons of investments in the United States like mortgage-backed securities and U.S. Treasuries. They needed dollars to do this, and U.S. banks were willing to lend them those greenbacks. So European banks filled with European money started to owe a lot of U.S. dollars. Which is fine, until no one in the United States wants to lend to Europe anymore.

Hence the Fed rescue. So when we hear that U.S. dollars are flying off the shelf in Europe, that the Fed is shipping over currency by the billions, what you are seeing is the invisible ties between U.S. and European banks. The more dollars they need, the more it becomes clear that European banks are intricately linked to the U.S. economy. We may send them our money, but the risk of European failure flows in the other direction.