Montreal, Canada

Over the last several weeks I've been warning about an imminent sovereign default as a direct consequence of profligate government spending since late 2008. Dubai and Greece are the latest victims threatening default. Abu Dhabi's $10 billion dollar rescue of Dubai has delayed its day of reckoning; Greece, however, requires some sort of major European Union bailout initiative if she is to avoid an outright default.

Greek government bond spreads have surged over the last two weeks against most credits, especially German bunds or government bonds.

Investors have ratcheted short-term Greek bond rates to about 3.35% compared to 1.27% for short-term German rates. Investors are rightly concerned about Greece servicing its debt obligations. Greece has the highest debt-to-GDP ratio in the Euro-zone and has already violated the EU's strict budget deficit limits along with Ireland, Portugal, Spain, Italy and even Germany since 2008.

Over the last 60 days smaller banks in Europe, including German Landesbanken, or mortgage banks, have reapplied for government financial assistance or received fresh bailouts. This applies to several institutions in the Baltic Republics, the Balkans, Holland, Greece, Spain, Germany and Austria. The credit crisis is far from over. Banks in Europe remain heavily leveraged to the real estate cycle, particularly in the Baltic Republics and Balkans.

For all intents and purposes, the euro's Maastricht Treaty, which governs member participation and restricts budget deficits to 3% of GDP -- is a joke. If the system's anchor, Germany, has violated the treaty then it has already been rendered obsolete. Europe's growing debt woes might act as the catalyst for a euro bear market – a possibility I've been suggesting for several months because the euro is heavily overbought and expensive while most things American are inexpensive.

The cost to support the existing financial system has been enormous and if another recession or double-dip arrives in 2010 or 2011 we can expect a blow-up somewhere. Greece and Dubai are peripheral systemic threats but nevertheless remain a sobering reminder of the fragile state of the global economy. The debt super-cycle, famously coined by Montreal-based Bank Credit Analyst, is approaching dangerous levels; like a rubber band, nobody knows how far it will stretch before violently snapping back. Just how much debt can the system handle?

Credit default swap rates have risen markedly for sovereign government bonds over the last three weeks. After calming down since March when financial markets hit a bottom investors are growing nervous again about government debt financing and pushing the cost to insure against default to the highest levels in nine months; the issue now is whether Greece will receive a broad-based EU bailout, which must be sanctified by all members, especially the Germans.

In all of this confusion and quiet panic, the markets have blown off the worst-case scenario and continue to rally. Even gold prices have come off their recent highs on December 3 at $1,217 an ounce. Usually amid growing fear the VIX will rise and Treasury bond yields will decline; neither scenario is unfolding.

Still, there's a disquieting sense across world markets since late November as credit issues continue to dominate global finance and the threat of some sort of central bank monetary policy bungling – whether in the U.S., Europe or elsewhere – triggers a severe market panic.

The next crisis is unfolding before our very eyes. Either currencies or debt markets will blowup next. The U.S. dollar, gold and the VIX are likely to produce the biggest gains if financial markets dislocate again as I expect in 2010. Of the three plays, the VIX offers the highest reward at these low levels but also the highest risk.