China is letting its currency, the yuan, off the leash a bit. The move has reawakened fears that the voracious Chinese will eventually back away from U.S. government bonds, boosting interest rates for Americans already in hock up to their eyeballs.

But by now, what our top overseas creditors might do in a couple years is almost beside the point. If the United States can’t bring itself to shore up its tattered balance sheet — particularly by imposing a politically unpopular squeeze on costly entitlement programs — a dollar crisis is inevitable, whatever the trigger.

“In order to continue to attract foreign capital, the United States needs to control its appetite for it,” University of Virginia professor Francis E. Warnock writes in a report issued Monday by the Council of Foreign Relations.

The dollar’s strength at a time of soft economic growth and massive deficit spending has been one of the top economic stories of 2010. Government borrowing costs have fallen even as debt piles up and the U.S. trade deficit resumes widening.

Warnock says we shouldn’t kid ourselves about the source of the dollar rally, though. Money is pouring into U.S. bonds because the euro appears on the verge of collapse, he writes, not because the United States has covered itself in glory during the financial crisis.

This is important because it means the dollar renaissance is vulnerable to threats as mundane as competent policy-making overseas.

And while the oft-discussed collapse of Treasury prices remains unlikely at a time of massive deleveraging, a rise in borrowing costs certainly wouldn’t be welcome news to anyone with the economy sputtering along.

This, Warnock writes, should light the fire under U.S. leaders who haven’t exactly been champing at the bit to confront tough choices on spending and taxes.

“U.S. policymakers need to understand that this is not a reset, not a new beginning; it is a lucky break,” Warnock writes.

The yield on the 10-year Treasury note has tumbled to a recent 3.3% from 4% in April, as investors have fled the quaking markets of Europe. Net flows into euro zone debt instruments plunged by almost half between 2008 and 2010, while foreign flows into Treasurys more than doubled.

But this, Warnock argues, is more a case of the structural strength of U.S. financial markets than a vote of confidence in the United States’ finances.

“The eurozone crisis seemed to remind investors of a point that had been obscured by the credit crisis: For all their imperfections, U.S. capital markets have powerful advantages over foreign rivals,” he writes.

And those advantages aren’t ironclad, even if policy-making across the Atlantic currently appears even more dysfunctional than the goings-on in the Beltway.

Southern European states such as Greece, Spain, and Portugal have been plunged into deflation, while sounder nations such as Germany find their growth prospects constrained. There seems to be little will to tackle the problems, which surely will be costly for all involved.

Yet should euro area officials find a way to bridge their political differences, it could lead the way to a reconstituted and strengthened euro zone. That could give Europe deeper and more liquid bond markets that would rival the one that now draws money into Treasurys every time global risk appetite wanes.

“The eurozone, if it holds together, now recognizes the need for a unified sovereign bond market,” Warnock writes. “The newly created bailout facility will be financed partially by eurozone bonds, and proposals exist to go much further.”

The creation of a deep European bond market won’t itself drain demand for Treasurys, of course. And European states have more than enough entitlement problems of their own to deal with.

But if U.S. leaders keep booting issues like deficit reduction down the road, someone — whether based in China, the United States, or elsewhere — is going to cry foul at some point.

Though President Obama’s deficit review commission (principals pictured above) “has been written off as a political sideshow by many commentators, a failure to act on its proposals will jeopardize U.S. economic and national security,” Warnock warns.

That means our solons in Washington must make the tough choices before the loons in the bond market do it for them.