JOHN Maynard Keynes is best known as the economist who gave his name to the term Keynsianism. However, in many ways, he was most successful as a City of London fund manager. He attributed it to understanding the psychology of the herd, rather than an understanding of the fundamentals, which are supposed to determine share prices. Had Mr Keynes lived to observe the astonishing vision we know as the Stock Exchange of Hongkong, he would have found himself gloriously vindicated. The latest manifestation of herd psychology has been seen in the avid buying of so-called red-chip shares - counters controlled by mainland-owned companies. A glance at the Red Chip Index, devised by Dao Heng Securities, shows that these shares have consistently outperformed the blue chip Hang Seng Index for the past two and a half months. The index does not reflect this; but it is also true that red-chip flotations have invariably been met with the sort of buying frenzy which sets world records for new issues. The logic for this red-chip mania, is that companies controlled from the mainland benefit from the economic and political connections, which are well placed to capitalise on China's booming economy. This is not entirely to be dismissed as a way of planning investments, but is inherently dangerous. The dangers were vividly illustrated over the past week when China's currency went into a free fall. The devaluation is by no means over, nor are the other problems associated with an overheating economy. The red-chip stocks are especially vulnerable to shifts in China's economic policy and changes in the economic environment, as they tend to represent companies at the cutting edge of the open-door policy, known elsewhere as capitalism. Many of these companies have invested heavily in Chinese residential property developments. This helps them present healthy-looking asset backing for their shares. However, it is almost certain that Chinese interest rates are going to rise sharply, a development which can only lead to a fall in property prices. As for the trading activities of these companies, take the example of the Denway wonder stock, which came to the market in February, securing a 658 times rate of oversubscription and pulling in over $240 billion. Denway's main business is assembling Peugeot vehicles for the Chinese market. It requires vast amounts of foreign currency to buy components and derives its revenue in the fast-disappearing local currency, albeit the much discredited Foreign Exchange Certificate of the Yuan. No wonder that its share price is languishing around an all-time low. Many of the other red chips are in a similar fix. However, at least one - China Travel - is well positioned to benefit from the foreign exchange chaos. The company has most of its earnings in foreign currency and the bulk of its costs in the local currency. It also enjoys a monopolistic position in many aspects of China's overseas travel trade. However, China Travel is only one of the two least liquid red-chip counters. Like China Overseas Land, no more than 25 per cent of its equity is available to the public. At least investors know something tangible about China Travel, which had a front-door listing, complete with a detailed prospectus. The problem comes with the growing crop of backdoor listings - where established companies are taken over by China-controlled corporations, which use them as shells to inject new assets. Zhou Beifang, who heads Shougang Holding (Hongkong), is emerging as a kingpin of the back-door listings. Armed with the political connections of his father, Zhou Ganwu, who runs Shougang steel corporation in China, the younger Zhou has built up a stock of four red chips and potential red chips - Tung Wing, Santai, Eastern Century and Kader Investments. Assets are shuffled in and out of these companies with alacrity. Investors have trouble finding out what these companies do, yet alone what they are supposed to own. However, Mr Zhou's blue-chip connections seem to override concerns over his red-chip dealings. On top of his backing in China, he has developed ties with Li Ka-shing and gained admittance to Tsui Tsin-tong's high-rollers club, the New Hongkong China Group. It is all very impressive; almost as impressive as the hefty price earning ratio (PER) on the Santai shares, which stand at over 30 times earnings. Investors wishing to know the prospective PER of Tung Wing Steel will have to be patient as the company istoo much in a state of flux for any sensible figure to be given. Indeed, patience is the order of the day for a total of nine stocks in Dao Heng's list of 23 red chips. None of them are in a position to give shareholders an indication of how many times their earnings will cover the price of the shares. HOWEVER, the average PER of the red chips as a whole - the 14 counters which offer this insight - reveals that their earnings equate to around 18 times their price, which compares with the market average of about 12 times. When the price earnings ratio rises into the high teens, the question of value for money comes strongly into play. In the mysterious world of red chips, it is often hard to determine exactly what value is vested in the shares. There are, of course, exceptions. CITIC Pacific, despite its demanding valuation, has clearly identifiable assets. It has stakes in solid and well-performing companies and a host of others queuing up to join the CITIC club. China Travel and China Resource Enterprises are also more transparent and solidly-based companies. The red chip bubble is bound to burst. As ever, the smaller shareholders are likely to get burned more than others. It is not that the smaller shareholders are less intelligent than those in the bigger league, but they are less likely to be tipped off when problems arise. Dao Heng Securities head of research and marketing Alex Tang, who has made a study of red chips, reveals that his firm's recommendation to investors is to stay out. ''We never recommend these kinds of stocks. They are really speculative plays,'' he says. However, Mr Tang's advice is likely to fall on deaf ears. Hongkong investors should at least try to learn something from the bubble history of the Hongkong stock market. Unfinished Business is a fortnightly column which will be looking at business matters deserving investigation. We welcome readers' suggestions and comments. There is no need for suppliers of information to be identified, although we will need to verify any material received. Unfinished Business can be contacted in confidence on telephone number 549-2470 or by fax at 547-5478.