About 12 months ago at a Sovereign Society conference in St. Kitts, I asked the audience if they were bullish or bearish about the U.S. dollar's prospects. Not surprisingly, the majority of respondents were extremely negative on the dollar and wanted to increase their exposure to other currencies like the euro and gold.

That sentiment was also echoed at other seminars since 2002 as most investors don't trust the dollar's long-term prospects and naturally, I could not agree more. I think you have to have your head examined to be a long-term dollar bull.

It's incredibly alarming, frightening, how the United States has destroyed its balance-sheet over the last several years, including two military conflicts, a protracted credit crisis costing the country trillions and massive trade and budget deficits. Just staggering.

Back to the euro...

When the tide is overwhelmingly tilting to one side of a trade, you know the cliff isn't far. Sentiment was so excessively bearish on the dollar last winter that I warned against dumping the buck against the euro but recommended gold and the Japanese yen. I also plugged the Chinese yuan and Singapore dollar -- relatively flat over the same period.

Another dollar bull at the time was Jack Crooks, probably one of the best currency traders I know. He remains dollar bullish.

Well, twelve months later the euro has gone from darling to dog among currency investors and seems poised to unravel this year as the credit crisis comes home to roost in a big way as weaker EMU (European Monetary Union) members come undone.

Credit spreads among weaker participants like Spain, Greece, Portugal and Italy have risen sharply over the last three months versus German bunds or bonds -- the anchor currency of EMU.

The odds are growing that one or several EMU members will leave the euro-zone.

Yesterday, S&P downgraded Greece's sovereign debt rating, citing eroding competitiveness and a rising fiscal deficit. Spain is also about to be downgraded.

Over the last four months several euro-zone countries, including even Germany, have reduced or scrapped bond market auctions because of tepid demand. And I ask myself how on Earth is the United States going to con the rest of the world raising more than $3 trillion dollars of debt issuance in 2009 and 2010 to fund this never-ending bailout and massive fiscal spending bill? The Germans have a fraction of America's debt and have reduced or canceled auctions.

Yet the Europeans have some serious challenges ahead.

Rumors are circulating in Europe that Ireland is seeking economic aid from the International Monetary Fund (IMF) -- vehemently denied by the Irish government. It's hard to believe than an EMU member might need IMF assistance -- a first, should it occur since the creation of the European single currency in 1999.

This is not the first time Europe has experienced currency volatility.

Back in September 1992, the euro's predecessor was the ECU or European Currency Unit. Though a synthetic unit prior to the euro's introduction in 1999, it served as a model for monetary union through the creation of ERM or the Exchange Rate Mechanism, which served as a guideline for those currencies in the grid. If countries were in accordance with spending guidelines then their underlying values would rise and if they exceeded budget limits then they would decline.

As economic recession took its toll in Europe, the British pound and the Italian lira bid adieu to the ERM and exited the exchange rate grid with humiliating devaluations in September 1992. Both the British and the Italians devalued their currencies about 20% and George Soros of the Quantum Fund earned almost $2 billion from shorting the pound ahead of its ERM exit. 

The euro will survive. It's already a hard currency widely in circulation and increasingly held at central banks worldwide largely at the expense of the dollar. Yet it seems highly possible that credit contagion will spell the end for weaker peripheral members which really had no business joining the euro-zone in the first place. It also bodes poorly for prospective currencies in the Balkans, Baltics and Central Europe where fiscal deficits are soaring.

In this environment I continue to view gold as the ultimate currency. All currencies have declined vis-a-vis gold since 2005 and I expect that trend to accelerate as currency chaos spreads to Europe.