Lord Chaos,
I know that Linux and DOS can both be installed on an external USB hard drive. If the BIOS doesn't support booting from a USB device, it's true that you may have to create a bootable CD/DVD or diskette that points to the external USB drive.
NTFS is problematic on external drives because NTFS is not a friendly filesystem with any type of removeable media. There are ways around this - but this is essentially why those external USB hard drives and flash drives are all formatted as FAT or FAT32.
There are lots of folks out there who have come up with workarounds to the USB Hard Drive boot issue as it relates to non-USB bootable BIOS, formatting these drives as NTFS and even installing Windows XP on them.
XP on a USB Drive:
http://www.ngine.de/index.jsp?pageid=4176
There are also lots of 3rd party utilities out there which allow booting of various OS's from external USB hard drives.
Again - what you're attempting to do IS "do-able" - just not necessarily a Microsoft sanctioned/supported solution.
- John