If cities are on different continents you can have them separated by only one water tile. I have thought the reason for the spacing was to make bombardment simpler--if cities must be two piles apart, your artillery can only be adjacent to one city at a time. But a battleship between two cities separated by a one tile straights will randomly pick one when told to bombard.
In civ 3 Infinite City Sprawl was one of the main exploits. The AI spaced them out to optimize the entire fat x, which meant that for most of life they weren't using a lot of land. By packing cities tight (one per 9 squares) a human could do something unique and gain an advantage. In civ 4 the AI strategy is closer to an optimal strategy, so the limit is a good thing.
That being said, it's
<Define>
<DefineName>MIN_CITY_RANGE</DefineName>
<iDefineIntVal>2</iDefineIntVal>
</Define>
in GlobalDefines.xml, the xml file in the xml folder but not in any subfolder.
MicroMod attached, it works.