either:
In the 1700's a new method of resuscitation was used. This "new" procedure involved blowing tobacco smoke into the victim's rectum. According to the literature, smoke was first blown into an animal bladder, then into the victim's rectum. It was used successfully by North American Indians and American colonists an introduced in England in 1767.
Or:
During WWI, in the trenches, at night, the snipers would shoot at anyone that they could see above the level of the trench. The allies started using dummies to draw their fie and would then fire back at the muzzle flash. After a while the snipers got smart and waited to see a sign of life from the figure they saw so the allies ran a tube up the back leading to the mouth. They would push the dummy up enough to be seen and then blow smoke through the tube so that it looked like it was being blown out by the dummy and would shoot at it. Hence, "Don't blow smoke up my ass" meaning don't make me out to be a dummy.
Or:
The phrase "blowing smoke", meaning to deceive and/or distract, has been around for years. The "up ones ass" part is a fairly new addition. The origin of the "blowing smoke" part is from stage magic, where magicians use smoke to hide their actions or to distract the audience. So if your actions were meant to distract or deceive, you were said to be blowing smoke. Of course, anyone who studies American slang knows that pretty much any phrase can be improved by adding a reference to someones ass, so I suppose it's inevitable the that is where the smoke would eventually be blown.