One of the key catalysts for Wednesday's market rout which originated in Europe came following news that Chinese banks had cut down on their credit lines to Europe, which highlighted the key threat to the European banking system: access to liquidity. The Chinese reaction is merely a symptom of a much deeper underlying ailment: the increasing lack of counterparty confidence across various funding markets, both traditional and shadow, which has continued to accelerate over the past week, a development summarized effectively by the latest report in the International Financing Review which uses some powerful words (of the type that European bureaucrats hate) to explain where Europe stands right now: "credit taps run dry for European lenders, setting scene for liquidity crisis." For those strapped for time the take home message is that: "with bond markets shut and investors unwilling to buy asset-backed securities, the repo market – for some banks the sole remaining source of private funding – has become the most recent tap to run dry, with some investment banks pulling credit lines worth tens of billions of euros in recent weeks." This is very disturbing as with liquidity windows shut, Europe's bank have no recourse on how to roll the €4.8 trillion in wholesale and interbank funding which expires in the next two years. End result: the only recourse is the ECB, which unlike the Fed, is not suited to be a lender of last resort and has been morphing into that role over the past year kicking and screaming. And when that fails, there are the Fed's liquidity swap lines. Too bad that the liabilities in the European banking system are orders of magnitude bigger than in the US, and should this liquidity crisis transform into its next and more virulent phase, even the Fed will find it does not have enough capital to prevent a worldwide short squeeze on the world's carry trade funding currency (once known as the reserve currency).