Holy Karl Marx, Batman. China is set to introduce futures contracts on its stock market indexes. Perhaps in March right after the Communist Party’s annual congress, Bloomberg reports. China’s Financial Futures Exchange has been running mock trading in the contracts since the end of 2006.

For the first time investors in China would be able to short China’s stock markets. The first contract is likely to be based on the CSI 300 Index.

This is a hugely important move both in the short and long term.

In the short term, introducing a futures contract will give investors a way to hedge against the tremendous volatility of China’s stock markets. That in itself should help reduce the volatility. Without the ability to hedge, investors worried that the market might be ready for a correction after one of China’s typically huge rallies have no alternative but to sell and move to cash. That creates exactly the kind of huge collapse that these investors were looking to avoid. In 2007, for example, China’s benchmark CSI 300 index almost doubled. It then fell 65% in 2008 before rebounding by 80% in 2009.

In the long term, the move to introduce futures contracts is part of a trend in China and other emerging countries to create financial markets that are a match for the strength and depth of their manufacturing economies.

This is the other side of the story that I wrote about in my 8:30 post this morning https://jubakpicks.com/2010/01/06/emerging-markets-are-getting-too-popular-again/ . Yes, as Mark Mobius warns, emerging stock markets are seeing a frenzy of stock offerings that is driven by the lofty prices awarded to emerging market stocks right now. And this huge new supply could damp gains in those markets this year. (Or even turn gains into losses.)

But all that stock being sold in Shanghai or Sao Paulo rather than New York, London, or Tokyo is a sign that emerging country stock markets are becoming serious alternatives to the financial markets of the developed world.

Those markets have got a long way to go in transparency, regulation, and liquidity. They, especially China and India, need to end restrictions on the ability of overseas investors and institutions to buy and sell stocks on their markets. They need to increase the float of “public” companies so their stocks and minority shareholders aren’t at the mercy of buying and selling by family or government owners. And they need to develop the full range of derivative instruments that allow investors to hedge risks.

The move to create a futures contract on the CSI 300 index is part of that story. China’s leaders know that if their country is to achieve its economic goals it will have to ultimately develop a financial system that matches its industrial clout.

Ultimately that will require an end to the myriad restrictions on the free flow of capital in and out of China including ending the country’s artificial pricing of its currency. That’s a project that will take more than another day to accomplish. Meanwhile, a futures contract would be a big step forward for this emerging financial market.