that's a very nice little strategy, being the hole in the babylonian donut.
Two problems: firstly, surrounding yourself w/ the Borg, i mean Babylonians, is risky as they generally have such a strong culture you risk having some cities assimilated. if not, fine.
the second problem is more serious. the one real problem w/ Diplomacy in CivIII is with trading cities. the AI vastly overvalues any city trade you offer. I've had to give up ever selling any cities because its too unfair. I just give them away (if they're some shithole i don't want) or add them in as a peace negotiation bonus (which at least makes some sense).
other than that, the surround strat is cool for deity. winning, however, is anothe matter