Stock markets in Hong Kong and Shanghai are jumping up and down like a kid on a trampoline.

For the last few days, Hong Kong stocks have taken something of a beating, returning to pre-New Year’s Day levels. Mainland stocks, however, were all the rage on Tuesday, led by China Life’s spectacular A-share listing.

During the first day of business after Christmas and again in the New Year, the Hong Kong Stock Exchange climbed more than 400 points while the Hang Seng Index topped the psychological 20,000 barrier.

On Thursday, the Shanghai Stock Exchange jumped up almost 6% and then dove back to close only 1.5% higher. On Friday, the Hang Seng index continued a drop that started Thursday but, as these words were written, seemed to be hanging in just above the 20,000 mark.

The old story about the Rockefeller scion that pulled out of the market after his shoe-shine boy gave him some stock tips is on everybody’s lips.

Taxi drivers and migrant domestic workers in Hong Kong are now investing on margin, borrowing money to buy stocks and get in on oversubscribed IPOs, one market watcher said.

Meanhiwle, analysts repeat time and again that there is too much liquidity. And, time and again, they follow that up with reassurances that fundamentals are still strong and getting stronger.

Yet, price-to-earnings ratios in Chinese insurance companies’ Hong Kong H-shares, typically an investor favorite, are at stratospheric levels. The stocks may be significantly overvalued but they are not the only ones - telecoms are getting up there and the once undervalued Chinese banks are following suit.

“People in Hong Kong have short memories,” said one acquaintance who follows the markets. “They don’t remember what it’s like to be in a crash.”

Many a trader got a nice surprise on January 2 and many a trader cashed in on January 3, causing the Thursday drop in Hong Kong. Friday was underlined by another drop and a slump in the US caused every market in the region to slump with it. Tuesday, however, things seemed to be back to the green across the region, except in Hong Kong, which started out on a high and closed in a low.

Still, the ride is great for now but, sooner or later, something will happen to bring everybody to their senses. New currency regulations in Thailand? A shock in Mumbai? An unexpected decision in Shanghai? God forbid, an earthquake in Tokyo?

Those who can ride the crash or slump will nervously laugh it off.

Investors who look at buying on margin as a sign of manhood will feel the pain as will the much less capitalized taxi drivers and domestic workers who have caught stock fever and are betting everything they have, and some stuff they don’t, on a fickle and often intractable animal.

John Thain, the head of the New York Stock Exchange, is in China looking to drum up business.

As well as setting up an office in Beijing, he has been busy pressing the flesh and emitting the sound bites, which included a criticism of pending legislation that would allow the regulator to keep a closer watch over companies seeking to list abroad.

“Companies need access to capital, they need access to global investors … so to restrict them from doing that will hurt their own business, and therefore ultimately hurt the Chinese economy,” Thain said.

While it’s fair to say that Chinese companies need more capital-raising options, this does not necessarily equate to more business for the NYSE, regardless of whether or not restrictions are placed on overseas listings.

The days of the big money Hong Kong-US dual listings by Chinese companies are over. In 1993, Shanghai Petrochemical listed in New York because the target figure (US$343 million was raised) was thought to be beyond the reach of the Hong Kong exchange. With the lion’s share of Industrial and Commercial Bank of China’s world record IPO under its belt, there is now no question that Hong Kong has the necessary pulling power.

When Dealogic combined Hong Kong with the resurgent domestic markets in Shanghai and Shenzhen, it calculated that US$43.1 billion had been raised in the first 10 months of the year. London (LSE and AIM – US$40.5 billion) and New York (NYSE, NASDAQ and the American Stock Exchage – US$38.3 billion) were trailing.

There is no question that Chinese companies still need to go to America in search of funding. China’s 2006 figures are inflated by two bumper IPOs by state banks – while there may be more deals next year, it’s quite possible the cumulative total won’t surpass this year’s – so it would be wrong to say the country is in the process of overtaking London and New York.

Furthermore, there is a fast-growing Chinese private sector up for grabs and investors appreciate the easy exit offered by an overseas IPO.

Stock exchanges have to market themselves to Chinese companies in terms of what they offer that others cannot. For NASDAQ, it is access to tech-focused investors; for London’s AIM market, it is a shepherding system that takes the burden of the paperwork away from what may be an inexperienced management team.

NYSE is no longer in a position to march into China and sell itself on the virtue of being the biggest and best – the “Blue Riband” listing and good corporate governance kudos come with a significant price tag in the form of Sarbanes-Oxley compliance expenses.

The NYSE may have an agreement with the Jiangsu provincial authorities making it the “US stock exchange of choice”. But local companies will need good reason to go abroad when they know they can raise all the money they need at home and in Hong Kong with far smaller compliance hurdles.

NYSE bought the electronic Archipelago stock exchange with a view to catering more for the smaller companies. It remains to be seen whether this will pay off in China.

The dollar is plummeting, other currencies including the Euro and the yen are surging. One of the reasons was a comment from the governor of the Chinese central bank. How times change. China is currently said to be reconsidering its dollar holdings versus shifting portions of its foreign exchange reserves into other currencies. Carl Weinberg, whose High-frequency Economics is one of my must-reads, is skeptical of this view, which means we must be cautious. But the forex volatility raises for me the question of when the RMB will become a reserve currency. It will surely happen one day, and China can only gain from other countries investing in its currency. But that can only happen, of course, after China makes its currency freely convertible. It is time.

There was an interesting article in the South China Morning Post today (sorry, subscription required) about China’s securities regulator extending a ban on foreign investors buying into the country’s securities brokerage sector.

In a typical example of the tenuous link between law and actuality in China, the ban was enacted in September this year. However, everybody knew the ban has been in place since the end of 2005, although it was never formally acknowledged.

Regardless, Swiss Investment bank UBS has been ploughing ahead with its attempt to take a 20% stake, and de facto management control, in troubled domestic brokerage Beijing Securities, although the regulator is forcing it to jump through hoops in the process.

Goldman Sachs has also made inroads through a complex (or perhaps simple) financing arrangement with Beijing Gao Hua Securities Company Limited. The securities firm, which is fully licensed to engage in the domestic securities brokerage and proprietary trading businesses, is owned by a group of investors led by Fang Fenglei, a well-known China investment banker. However, the brokerage was basically paid for by the secretive US investment bank.

When regulatory conditions allow, Goldman will, by all accounts, exercise its option to take formal ownership of the brokerage, and its valuable domestic securities brokerage and proprietary trading licenses. In the meantime, it has full run of the place anyway. (The two firms are partners in the joint venture Goldman Sachs Gao Hua Securities Company Limited, but Goldman Sachs has access to secondary trading in the domestic markets through its JV partner, not the JV itself, hence commonplace confusion over the legal and operational status of the arrangement).

How long it is until regulatory conditions allow for official foreign entry remains up in the air, but it is certain the sector will not be reopened until the China Securities Regulatory Commission finishes recapitalising and restructuring the country’s 108 remaining brokerages, and consolidating them through mergers and acquisitions. The SCMP reckons that could be next August, although my money says that will be the absolute earliest.

What the CSRC is trying to avoid is a repeat of London’s Big Bang, which occurred when the LSE dropped barriers to foreign participation in 1986: it cemented London as the heart of European investment banking, but also devastated the city’s brokerages.

The Japanese coined the term the “Wimbledon Phenomenon” to describe the paradox: although Britain provide’s the world’s foremost tennis tournament, domestic players are poor, and the winners are all foreigners.

According to one financial sector official I spoke to a couple of months back, the CSRC has not even drawn up their strategy for opening up yet.
That’s why Goldman and UBS are allowed in. Their job is to import Wall Street principles and practices, preparing China’s players to win at home when the foreign invaders breach the gates. More importantly, they are also here to teach the CSRC how to officiate and interpret the rules. After all, you need to know the rules to bend the rules in favor of the home team.

But the job is a long way from being done. Until it is, China’s answer to Tim Henman, Britain’s best Wimbledon “hope” and perennial early round exiter, will continue to enjoy home court advantage. Now he is winning by ignoble default, and the CSRC is unlikely to change the entry criteria until it is sure its Henmans will win through a superior game.

Probably combined with a subtle home court advantage, courtesy of the court side officials.

The People’s Bank of China raised the reserve requirement ratio for commercial banks 50 basis points Friday to 9%, effective from November 15, the third such hike this year.

The news has been viewed as another step in the central bank’s war to peg back economic growth, which scorched across the financial world’s consciousness at 11.3% in the second quarter, the fastest in over a decade, before pulling back slightly in the third quarter. The theory goes that by reducing the amount banks can lend, the move will peg back fixed asset investment which, alongside the surging trade surplus, is held to be primarily responsible for the booming economy.

But as JP Morgan pointed out in a research note over the weekend, the move will have little, if any, effect on bank lending. The gist of the argument follows:

“As we have noted earlier, the central bank’s RRR rate hikes so far this year has not really led to significant tightening in overall monetary conditions yet. Indeed, excess reserves of all financial institutions still stood at 2.52% at the end of September, though it did come off from 4.17% by December 2005. In effect, banks seem to have been cutting back the excess reserves to fulfill the 1% increase in reserve requirements (50bp hike effective in July and August respectively). Thus, by hiking the official RRR further, the central bank aims to further “lock in” the excess liquidity at the commercial banks, rather than leaving the room for such excess reserves to be leaked back to the market/economy at any time. In short, only when the official RRR rises towards 10%, as we expect, will further adjustments in the RRR become “effective binding constraints” on overall liquidity conditions in the banking system.”

So, because banks already have greater reserve positions than required, the hike will have no impact. And even if it did, would it really slow the economy? Probably not by much. Although it is true that new loans are well above government targets, it is also true that bank lending has very little to do with the spiralling investment situation, with the bulk of fixed asset investment growth driven by retained earnings rather than bank credit. Therefore, even if bank lending were a more significant factor in booming fixed asset investment and growth, the move would have no impact.

So why do it? According to JP Morgan, the latest decision is part of a move to normalize overall monetary conditions rather than “excessively tighten the monetary environment”.

As the PBOC pointed out in its press report, overall liquidity in the banking system is still moving in the wrong direction due to sustained balance of payments surplus. This puts pressure on the banks to increase their lending to stay in the black, adding slightly to investment and growth pressures but considerably raising the spectre of more bad loans to come (does anybody remember bad loans?).

This, and not fixed asset investment, is surely the real concern for Beijing, particularly as the banking sector prepares to open fully to foreign entrants.

Here’s a guy who lays out a thoughtful explanation of why the worldwide headlong rush into ICBC (and BOC, CCB, etc) is mortal folly. As he explains it, “I wouldn’t touch a Chinese bank with a ten-foot pole.”

Certainly his argument is compelling. Chinese banks have bad lending practices. They are pressured to make loans to prop up failing SOEs and so end up with a ton of bad debt. They have relied on the government to save them from insolvency with injections of liquidity amounting to billions of dollars.

Not a good business to be in, to be sure. But why then do the likes of Goldman Sachs, Morgan Stanley, and UBS all want a piece of Chinese banks? Probably because the China story is dominating the economic headlines of the day, and growth throughout the country is off the charts. No matter how abhorrent their (former?) practices, China’s banks are going to play an integral role in the country’s development and everybody wants in.

It’s the same as the stock markets here. They’ve been in the tank since they were created 15 years ago and they’re still full of dogs. But eventually they have to turn, because the whole world has an interest in China right now and China is slowly letting them be a part of it. Naturally many of the punters lined up in Hong Kong to quickly turn a profit on a hot stock. But the big money is in China for the long haul - and its effect is bound to be a positive one.

This story from the People’s Daily is encouraging. It says that China’s insurers have started putting money into the stock markets. According to the CIRC, the insurance regulator, “at the end of August, Chinese insurance companies held investment assets worth 1.05 trillion yuan (133 billion U.S. dollars), including 49.9 billion yuan of shares.”

It would seem that the companies have a bit more faith in the market than they used to. Or perhaps they’re just under direct orders to put more money into the stock exchange. The government, after all, has been ferociously trying to get the markets off the ground, bring home star domestic companies who have forsaken them for New York or Hong Kong, and get those devilish foreigners to really start laying on the funds. The average Wall Street banker still considers China’s markets a joke. But serious people are paying attention, and are in for the long haul. Like UBS.

Of course, it’s not like the insurance companies have much choice. With policy sales going up and the population getting old, they need to make some good returns on their cash. They can’t just put it in the bank, as they’ll end up losing money after inflation. Recent purges in Shanghai have brought the legal status of investing pension funds in infrastucture projects into question. Historically the markets have not been a good bet. But things could be looking up…

Morgan Stanley annouced it acquried China’s Nan Tung Bank, and in the process picked up a coveted commercial banking license, allowing it to begin doing business in RMB-denominated transactions.

Nan Tung is a small bank, with only a single branch and less than 40 employees, but the deal includes that license and therefore is a major breakthrough for Morgan Stanley. Although some other foreign bank have the authority to offer yuan-based financial products on the mainland, Morgan Stanley’s US rivals Goldman Sachs, Merryl Lynch and Lehman Brothers do not.

The American investment bank will still have to apply for each individual product that it plans to release - not a simple process - but this is a major step out in front of its rivals in the lucrative Chinese banking sector.

Henry Paulson’s speech on the eve of his departure to the G7 Summit in Singapore should be compulsory reading for anyone interested in China’s growing role in the world economy.

Unlike previous bluster from the Treasury throne, Paulson takes the tone of a concerned parent. Yes, China is still growing, but it is old enough and big enough now to take responsibility for its actions. Those actions do affect the wider economy, and it is no longer immune from the repercussions of its actions.

Discarding the usual aggressive “revalue or face a backlash” stance of his predecessors, Paulson displays a nuanced understanding of the China miracle and, more importantly, the challenges that remain.

Sure China is now big and powerful, but it is also incredibly fragile. Its financial system is a mess, failing to fulfill its basic function of distributing savings to the most productive economic players, its social safety net is stretched so thin that Chinese consumers are scared to shop, undermining efforts to introduce balance to the country’s investment- and export- led growth trajectory, and its massive trade surplus is something the other kids in the playground are obviously not going to take lying down for long.

Where Paulson diverges from his predecessors - and the current China hawks filling up the airwaves with threats and ultimatums - is that he has dropped the “reform or we will launch a backlash” line and replaced it with “reform or we won’t be able to prevent a backlash” argument.

As Paulson knows, a protectionist backlash against China will benefit no-one. He also knows that a rapid appreciation of China’s currency will benefit no-one. The solution to the undeniable problems besetting China are much more subtle. But they are tied to reform, liberalization and a market-based exchange rate.

But China also knows this. Gentle reminders to take off the training wheels are the best way to encourage China to take the right path to reform. Who knows what path China will veer down if they are removed by force or threat.

Most high-flying bankers I come across don’t seem to spend much of their waking hours at play. A large amount of time is spent quite literally high-flying between Asia’s capital cities, moving from deal to deal.

So forgive me for continuing to be somewhat puzzled at the head of HSBC’s Asia private banking business having so much time to hone her salsa skills.

Monica Wong has won back the US$8 million she paid to her former world champion dance coaches as part of a of a 10-year US$15 million-plus deal for unlimited lessons and competition entries.

You have to praise her commitment, question her lavish spending habits and then ask where on earth she found the time.

Apparently, under a two-year US$1.3 million unlimited lesson deal that ran from 2002, Wong took six 45-minute lessons per day, seven days a week. Two lessons before breakfast, two at lunchtime and another two at night? It seems possible but I was just typing it out rather than trying to master a paso doble.

I have neither the money, inclination or coordination to frequent Hong Kong’s dance halls but salsa is said to be a must for those who want to generate social kudos at charity balls.

Therefore, having invested so much cash in profile-booster that became a passion, you can understand why Wong was miffed when her teacher threatened to throw her “out of the f***ing window” during a public dance session.

The teacher is now paying the price for his outburst. But with a department head so diverted, would it be worth HSBC carrying out a performance review at its private banking arm?