Greenback plunging to a record low against the Swiss franc

"The fundamental backdrop is not in favor of the dollar," said George Davis, managing director of global research at RBC Capital Markets in Toronto.

Investors are positioning for a scenario in which policy makers are unable to strike a deal, Davis said. "If we do get to the point where there is no agreement, we'll see a another leg lower in the dollar as the market prices in a more negative outlook."

Economists and politicians alike have warned that a downgrade or a default could trigger a financial panic that could rival the 2008 crisis. That helped send the dollar to its weakest level ever against the franc and a four-month low against the yen. Both are considered safe-haven currencies by market participants.

Late Friday, the euro was at $1.4391 from $1.4229 late Thursday, according to EBS via CQG. The dollar was at Y76.78 from Y77.69, while the euro was at Y110.05 from Y111.33. The U.K. pound was at $1.6414 from $1.6360. The dollar was at CHF0.7856 from CHF0.8011.

The ICE Dollar Index, which tracks the U.S. dollar against a basket of currencies, was at 73.750 from about 74.222.

Japan is struggling to rebuild from its nuclear and natural disaster, but with the dollar held in such poor esteem, the yen has surged as nervous traders flock to the currency as a shelter.

On the basis of its debt-to-economic-growth ratios, Japan is one of the most debt-laden major economies in the world. However, analysts say that because most of its obligations are to domestic investors, the country has little external funding needs, and therefore isn't as exposed to global economic tumult.

Japanese authorities have watched with dismay as a strong yen undercuts the country's exports, threatening to counteract rebuilding efforts. Traders were on alert for signs that Japan could intervene to weaken its currency.

"Assuming that we have failures on budget discussions here, which at this point is a pretty decent probability, then dollar/yen could break" sharply lower, said Richard Hastings, macro strategist at Global Hunter Securities. He doubted whether unilateral intervention could be effective.

That, however, didn't stop Japanese officials from warning they could do just that. Prime Minister Naoto Kan said yen moves had become one-sided--the latest and highest-ranking policy maker yet to caution the market about aggressive moves.

But a broadly weak dollar has exacerbated the strength of most currencies, creating a policy conundrum for other economies around the world. Just this week, the dollars of Canada, Australia and New Zealand all hit multiyear highs.