European rates are on the rise. The Fed is nearing the end of its rate-hiking cycle. Gold is glittering past $500 an ounce.

Does this spell doom for the U.S. dollar?

The ECB made the Euro more attractive this week with its first rate hike in half a decade, but the U.S. dollar is still up over 13% this year against the European currency. Axel Merk, portfolio manager of the $5 million ( MERKX) Merk Hard Currency Fund, says the dollar's dominance will soon come to an end as the ECB gets aggressive and the U.S. fiscal house gets messier. Merk's fund, which invests in short-term money-market instruments of countries pursuing so-called "sound monetary policy", is down 3.1% since its May inception. More than 40% of the fund is comprised of Euro-denominated short-term bonds.

TheStreet.com recently chatted with Merk to get the hard facts on hard currencies.

The European Central Bank raised rates Thursday for the first time in five years. Are there more hikes to come?

The ECB has signaled very clearly that it wants to raise rates, but at the same time it is under tremendous political pressure not to raise rates too much. They do not want the euro to get too strong so that European exports are affected. So the overall reaction was muted, because it was widely expected.

Is the ECB on the right path?

We see a central bank that is doing its job in reining in the countries that are too lax on the spending side. They are trying to police these countries, but they only have one tool, which is changing interest rates. So far, they are doing a good job playing policeman.

More than a third of your portfolio is in Europe. Which countries outside Europe are being fiscally responsible?

The countries that we like outside of the Eurozone are the commodity rich countries like New Zealand, Canada and Australia. Those are countries that are benefiting from the boom in commodities. At the same time, they also have central banks that are aware of the potential bubbles that could spring up from their hot economies.

We try to stay away from more speculative Asian plays, notably Japan. We believe that the Bank of Japan is often politically motivated to put exports ahead of price stability.

You also have a large stake in gold via the streetTracks Gold (GLD) ETF. Is this your statement on inflation?

Gold is the ultimate hard currency. It does not report to any central bank and is not subject to interest rate moves. Gold is benefiting from the negative real interest rates in America. We talk about low headline inflation numbers in the U.S., but most people agree that inflation is quite higher than stated in the core CPI. So when you put your money into a savings account you are losing purchasing power. As long as that is the case, gold will be an attractive alternative because it holds its value in an inflationary environment.

The dollar's rise in 2005 hurt your fund. What is your outlook for the dollar in 2006?

What is going against the dollar is that the ECB is starting to raise rates while the U.S. Fed is ending its interest rate hiking cycle. So the interest rate differential is going to decrease and the trend is going to change. Inflation is picking up in the U.S., which is a negative. And the corporate incentive to repatriate foreign dollars is also ending. The overwhelming theme, of course, is the dramatic current account and trade deficits, which continue to escalate.

But isn't the European economy in worse shape than ours?

The Europeans don't have a trade deficit. In fact, they have a trade surplus. And while the European economy has not done too much in the last couple of years, the savings rate has improved. When Europeans were told they were not going to have enough money to retire, their response was to save. When Americans were told that their pensions were in jeopardy, their response was to take more money out of their homes and charge up their credit cards, so savings declined. In the end, Europe is in a much stronger situation right now when it comes to saving, while America is in a weaker spot.

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