May 28 (Bloomberg) -- Treasury Secretary Timothy Geithner will urge China to boost domestic demand and loosen controls on the yuan in his first trip to the nation since taking office, while readying a defense on queries about sinking U.S. bonds.

In meetings with Chinese leaders in Beijing June 1-2, Geithner will encourage China to move toward a more flexible exchange rate, a U.S. Treasury official told reporters in Washington. He will also answering any questions the Chinese may have about the dollar or the U.S. budget deficit, the official said on condition of anonymity.

While delivering a familiar U.S. message on reducing China’s reliance on exports, the Treasury chief may meet an unprecedented level of concern about the outlook for Treasuries. China is the largest foreign holder of U.S. government debt, which has handed investors the worst loss since at least 1977 this year as forecasts for federal budget deficits ballooned.

“We’re going to be flooding the world with debt for a while,” said Tim Adams, a former U.S. Treasury undersecretary for international affairs who helped lead the Bush administration’s economic policy with China. “We’ve got to hope that that the Chinese are willing to keep buying.”

China held about $768 billion in Treasury securities as of March, according to U.S. government data.

U.S. Commitment

The U.S. is committed to reducing its budget deficit and maintaining deep and liquid markets for government debt, the official said in a briefing before Geithner’s May 30 departure.

To spur the U.S. economy, Geithner has said the administration needs to run deficits in the short term. For the fiscal year that ends Sept. 30, the deficit is projected to reach a record $1.75 trillion, according to a Congressional Budget Office forecast.

The widening gap has contributed to the tumble in Treasuries, which have lost 5.1 percent, including reinvested interest, so far this year, according to Merrill Lynch & Co. index data. The dollar has also been hammered, with the Federal Reserve’s trade-weighted Major Currency Dollar index sliding 3.2 percent so far this year.

Chinese Premier Wen Jiabao in March expressed concern about the value of the nation’s U.S. investment. Also in March, central bank governor Zhou Xiaochuan advocated a “super- sovereign reserve currency” disconnected from any individual nation, casting doubt about the long-term role of the dollar.

Wen, Hu Meetings

Geithner is set to meet with Wen during his trip, along with President Hu Jintao and Vice Premier Wang Qishan. In addition, Geithner will deliver a speech at Peking University on U.S.-China economic relations and take part in an economic development event that features U.S. companies.

The Treasury secretary is confident the U.S. dollar will keep playing an important role as a reserve currency for a long time, the official said today.

The Beijing talks will include the importance of open trade and the need for both the U.S. and China to move toward balanced long-term growth strategies, including a flexible currency policy, the official said.

Since mid-2008, when China’s leaders began to take measures to address an economic slowdown, the yuan has hovered around 6.84 per dollar. That rate was reached after a gradual appreciation since July 2005 from a level of about 8.3 yuan, a peg China had maintained since 1995.

So far this month, the yuan is little changed, closing today at 6.829 per dollar.

‘Manipulating’ Label

Geithner has avoided a showdown over China’s currency policy, declining to repeat comments he made in written remarks to lawmakers after his Senate confirmation hearing in January that China was “manipulating” its currency.

In its first semiannual report on foreign-exchange policies since Geithner became secretary, the Treasury said April 15 that while the yuan remains “undervalued,” it didn’t meet the standard for illegal manipulation in the second half of 2008.

China will need to keep buying dollars if it plans to keep the yuan tethered to the dollar, said Brad Setser, a former Treasury official who is now an economist at the Council on Foreign Relations in New York.

“If China insists on pegging to a now-depreciating dollar, it isn’t clear that China will be doing anything other than add to its dollar portfolio,” Setser said. “China’s public expression of concern about its dollar holdings is somewhat at odds with its policy of pegging to the dollar quite tightly.”

When notes and bonds of U.S.-backed companies such as Fannie Mae and Freddie Mac are included, China’s holdings of U.S. debt come to about $1.55 trillion, according to Setser. “China will certainly raise its concerns in some form,” he said.

Geithner, 47, will need to “say all the right things” about the U.S. fiscal shortfall, said Adams, who accompanied former Treasury secretaries John Snow and Paul O’Neill on trips to China. “There’s enormous concern about the size and intractability of the deficit,” said Adams, who is now a managing director at the Lindsey Group, an investment consulting firm in Fairfax, Virginia.

To contact the reporter on this story: Rebecca Christie in Washington at Rchristie4@bloomberg.net

Last Updated: May 28, 2009 17:02 EDT