At a conference for Asian government pension funds held in Tokyo this week, a senior government official from Singapore's $100 billion-plus Government Investment Corporation (GIC) expressed his concern about the sustainability of the United States' macroeconomic policy, outlining how this posed a major risk for Asian investors.

Teh Kok-Peng, president of GIC Special Investments, says the need for diversification and superior investment returns has driven Asian institutions to invest heavily in US securities. This is because Asian capital markets remain poor allocators of capital.

He cites a famous article penned by the economist Paul Krugman in Foreign Affairs magazine in the mid-1990s, which argued that Asia's economic 'miracle' was a demographic phenomenon and that Asian productivity was in fact quite low. While Teh does not fully buy the Krugman thesis, he does agree that returns on investment in Asia remain well below those in the US. The Asian financial crisis of 1997-98 made this fact brutally clear.

Since then, a major trend in global finance has been Asia exporting its capital to the US, usually in the form of central banks holding US Treasury bonds, which in turn finances America's deficits. This has both positive and negative implications.

"The US is a born-again developing country," says Teh, noting that like emerging markets, the US boasts a similar, youthful demography and imports global capital. Moreover, the US economy is dynamic and flexible, and its financial markets the world's deepest and most sophisticated.

The capital it imports from Asia, especially from China, is re-exported in the form of foreign direct investment. "The US acts as a financial intermediary because the Chinese financial system doesn't allocate capital properly," Teh explains, which is why regional government funds want to invest overseas.

In fact all of GIC's portfolio is international, much of it held in US dollar assets. While in theory new emerging markets should offer ageing societies the necessary returns on capital, these markets are decades away, while the US remains an attractive destination.

"If the US economy remains dynamic and credit-worthy, this trend can continue," Teh says.

But there is the rub: how credit-worthy is a country in such debt, both in terms of its fiscal policy as well as its current account? Teh has his doubts. He says in the 1990's, Amercian debt was fairly benign, as investment was pouring into productivity-raising functions like the IT boom. But today that debt reflects only consumer spending and an all-time low savings rate.

This creates a huge problem for institutional investors, he says. It is all very well to plod along following modern portfolio theory, matching assets to liabilities, determining your efficient investment frontier, setting a risk budget. But that assumes a 'business as usual' environment and Teh is not certain how sustainable this environment is, if the world's leading economy is perceived to be a credit risk.

This dilemma, as Teh calls it, has not yet changed the GIC's asset allocation or its US investment strategy. Instead the GIC diversifies its portfolio as much as possible, and because it has no home-market bias, it can claim to be more diversified than any US or European state pension fund. "If I may paraphrase George W. Bush, you can run but you can't hide," Teh says. "If there is an event in America it would have a tremendous knock-on effect around the world."