The dollar is dying, but guess who's giving it the kiss of life?

In the 14th-15th centuries, the Catholic Church introduced a system of “ indulgences ”, under which a believer could secure redemption in the afterlife for sins committed on earth. It’s like striking a good deal with your god: you pay money in this life, secure divine pardon, and are promised absolution when you die.

The thing about such “mercy-for-money” indulgences is that it could never be proved whether they work or not, since no one knows what happens to you after you’ve shuffled off. The entire system revolved around faith. So long as there were enough believers, the Ponzi scheme could be kept going.

Today, there’s a similar faith-based Ponzi scheme at work, centred around the US dollar, but this time, it’s the dollar that is on its death-bed and looking for absolution. The US is just days away from a default on its mountain of debt, which would have catastrophic consequences for the US economy (and for the rest of the world) and symbolise America’s decline as a fading global power .

But, bizarrely, politicians, operating in a parallel universe, have been playing a dangerous game of brinkmanship. They’re caught up in a class war, and can’t agree whether the debt burden should be reduced by getting the rich to pay marginally higher taxes or by cutting back entitlements on the poor and the middle class. Ideological rigidity has driven out every vestige of common sense, and toxic politics has spread venom into unyielding minds.

It’s almost as if, having gotten bored of being the sole remaining superpower, America has decided to self-destruct spectacularly.

So, is the dollar about to curl up and die? If so, what implications would it have for the rest of the world?

The dollar’s status as the pre-eminent global reserve currency gave the US an extraordinary privilege. It underwrote the rise of America as an economic and military power, and unleashed one of the most profound innovative forces. Countries around the world too fed off that boom, and over time, with the rise in global trade, they worked out an arrangement where they would take over the job of providing goods and service to Americans, who could sit back and enjoy their riches - and, when that got too boring, go on to wage unaffordable wars.

To keep the cycle going, however, they had to invest their earnings in US dollar assets, which would serve to keep interest rates low in the US, and allow for the gorging to continue.

And although the 2008 financial crisis momentarily ended that symbiotic cycle, it appears from all accounts that Asian governments, among the biggest accumulators of dollar assets, haven’t yet budgeted for a time when the US defaults or sees its sovereign ratings downgraded from its AAA level, as seems inevitable. And if it came to that, they would continue to purchase dollar assets even in the event of a downgrade.

Reuters reports , quoting an RBI official, that India “does not currently hold bonds rated below the top-tier AAA, but would probably have to if the US rating is downgraded.”

“We can only wait and watch,” the official said. “Alternate options like the euro are equally bad, and (British) pound sterling hardly has the depth to absorb this kind of investment.”

[caption id=“attachment_44460” align=“alignleft” width=“380” caption=“The US is just days away from a default on its mountain of debt, which would have catastrophic consequences for the US economy. Alex Wong/Getty Images/AFP”] [/caption]

Similarly, government officials in Japan, the second largest holder of US Treasuries (after China), say that “holding onto (US) Treasuries could cause some capital losses in case of a downgrade, but we could live with it…We have no problems investing in sub-AAA rated bonds…Besides, what else should we buy by selling dollars? Euros? Would that be a safer investment than the dollar?”

And although China has, in its public utterances, been talking down the dollar, its acquisition of dollar assets continues. That’s because China is caught in a “dollar trap”, and risks “financial suicide” in the event of a rapid dumping of dollar assets.

In other words, the dollar is today in a peculiar situation. While politicians in the US have, with their toxic politics, driven it to the brink of death, it is being given the kiss of life by emerging economies around the world that seem, for now, unable to go off their dollar addiction. Even in near-death, the dollar may perhaps be able to buy itself an “indulgence” that will allow it to secure for itself a life after death.