Dear Reader,

While the headlines often capture the quick swings in CDS prices or the rising interest rates on European debt, another - perhaps more important - story has been building beneath the surface of the European banks. According to a Bloomberg article, bank deposits have been slowly but surely leaving them:

Retail and institutional deposits at Greek banks fell 19 percent in the past year and almost 40 percent at Irish lenders in 18 months. Meanwhile, European Union financial firms are lending less to one another and U.S. money-market funds have reduced their investments in German, French and Spanish banks.

The European Central Bank can claim whatever it wants about the next bailout, but if the average guy on the street is not willing to put his money in any of their banks, the European financial system will see serious trouble. And these numbers are astounding. At 19% lower deposits for Greece and 40% in Ireland, this isn't a few paranoid folks pulling their money. On top of that, US money market funds have also been steadily pulling out as well:

A survey by Fitch Ratings showed that U.S. money-market funds reduced their lending to European banks by 20 percent from the end of May through July. The funds cut investments in Spanish and Italian lenders by 97 percent, to German firms by 42 percent and to French ones by 18 percent, Fitch said. The Aug. 22 survey covers almost half the $1.53 trillion assets held by money funds in the U.S.

Looking at the bright side of the Greek bailouts, they have at least bought everyone some time - time to get out of the European financial system, that is. I don't think the bailouts can avert the crisis, but perhaps they have slightly alleviated the global systemic risk. Certainly, these money market funds are in better shape today with less exposure to the eurozone than they were a few years ago.

To make matters worse for the European banks, they must now offer higher rates on deposits to attract customers. That means thinner margins on their loans and an even steeper road to recovery. Unfortunately for the banks, the higher rates are an unavoidable necessity. After all, when banks are paying next to nothing on deposits, it almost makes sense to keep cash tucked under the mattress. The opportunity cost of doing so is practically nothing.

Next, Kevin Brekke will relate how the evolving European crisis is affecting the dollar. The USD had remained surprisingly weak despite all the bad European news, but now it's finally gaining strength.

By Kevin Brekke

The two-week trading period of August 29 through September 9 saw the dollar undergo a rapid rise against many of the world's currencies. The renewed vigor in the greenback was in reaction to a flood of unsettling news: resignations at the ECB; uncertainty about Germany's participation in European rescue operations following a ruling by the country's high court; increased scrutiny of the solvency of EU banks; implied probability of Greek default nears 100%; rising rates on sovereign debt across Europe's core; and simmering fears that a slowdown in world economies might lead to another global recession.

There was no shortage of bad news, with much of it emanating from Europe. No surprise then that investors returned to old habits and bought dollar-denominated assets as a perceived sanctuary. The hot money flow spiked the US Dollar Index (DXY) - the most widely monitored and often-quoted gauge of dollar strength or weakness - from 73.69 to 77.15 (a 4.7% spike) in 10 trading days.

The DXY is a weighted index comprised of six currencies, shown here:

(Click on image to enlarge)

With the euro accounting for nearly two-thirds of the Index, the DXY is basically a measure of the US dollar against greater Europe. If we ignore the yen - not hard to do with its paltry 14% slice - the Index is actually confined to the currencies of countries in a narrow strip of the northern Occidental part of the world. This biased focus limits the use of the Index as an accurate barometer of the dollar's global standing. To remedy that, let's take a look at the exchange rate of the dollar against a broad range of currencies during the 10-day period stated above:

(Click on image to enlarge)

The chart displays currencies from the Americas, Asia-Pacific, Scandinavia, East-Southeast Europe, Middle East, and Africa. The recently widened trading band of the "managed floating exchange rate" of the yuan acted to accelerate its appreciation. Ongoing civil protests against despot governments throughout the Middle East seems to have caused a flow of money into the riyal and dirham, which are seen as safer havens within the region.

Yet, with a few exceptions, the dollar was higher against currencies spanning the globe. And the strength was more than a knee-jerk response to current events.

For each currency in the chart there are two columns: The left column shows the 10-day percentage rise, and the right column shows the rise since the DXY hit a 38-month low on May 2, 2011. So although the recent spike in the index accounts for a good part of the move, the dollar has been in a sustained, four-month rising trend.

For gold investors like us, a rising-dollar trend is something that gets our attention. Historically, gold and the dollar tend to exhibit a negative correlation, generally moving in opposite directions. And that had been the case until recently, as we can see here:

(Click on image to enlarge)

The left and right vertical axes are labeled in nominal values. However, from bottom to top, both scales represent a nearly identical percentage progression - similar moves in either series are of equal percentage. Also, the DXY scale was adjusted so that the two series crossed at a critical point.

We can see that a negative correlation between gold and the dollar was in place since March, exhibiting a near mirror image of each other. But the mirror was decisively smashed in late July, with gold putting in an impressive upward move. This was followed shortly thereafter by a thrust higher in the dollar, taking it above some near-term resistance levels.

The question now is: Can both of these moves hold? If the dollar holds at its current level and establishes a base, it is possible that we may be in for a multimonth period of dollar strength that could take the index back above the 80 level.

How might gold answer? With gold entering a seasonally strong period, the competition for haven status against a stronger dollar could dampen its seasonal upward tendency. On the other hand, days where gold has sold off have been on heavy volume, signaling that some speculators are using gold's strength as profit opportunities.

Whatever happens next, any strength in the dollar will be temporary. The runaway debt, deficits, and uncontrolled spending and borrowing of the US government have doomed the dollar to eventual destruction. View the dollar's strength as an opportunity to move US assets offshore.

Likewise, any drop in gold is a chance to add to your holdings. We at Casey Research have been banging our bloodied fists about this for a long time. Gold is definitely no longer cheap. But "cheap" is relative. When gold hits new thousand-dollar handles over the years ahead, today's price of $1,800 will certainly look cheap. To help overcome precious-metal sticker shock, start pricing things in gold, not dollars. Viewed from this perspective, gold is not expensive - it is the dollar that is worth les