REPORT: China's central bank emailed the Fed for advice on how to stop its stock market from crashing

Email fixes everything. Picture: The IT Crowd, BBC

On July 27 last year, the People’s Bank of China was facing a crisis in confidence. After rallying more than 150% in the preceding 12 months, China’s stock market was crashing before its eyes.

From the peak of June 12, the benchmark Shanghai Composite index plunged by 28% in just 30 sessions of trade, sparking a renewed wave of selling as market fundamentals and soaring margin debt acted in unison to drag the once high-flying market lower.

On July 27 things took a turn for the worse. Having rallied by more than 20% since July 9, the composite plunged by 8.5%, wiping out half of those gains in one horrifying session of trade. It was the largest one-day percentage decline seen since 2007.

The turmoil, unusual even by Chinese standards, prompted an even more unusual response from the PBOC: they emailed the US Federal Reserve for advice.

According to a report from Reuters, the PBOC asked the Fed on how to stymie the market rout, asking it to share its play book for dealing with Wall Street’s “Black Monday” crash of 1987.

In a message to a senior Fed staffer, the PBOC’s New York-based chief representative for the Americas, Song Xiangyan, pointed to the day’s 8.5% drop in Chinese stocks and said “my Governor would like to draw from your good experience”, according to documents obtained by Reuters as part of a Freedom of Information Act request.

“Could you please inform us ASAP about the major measures you took at the time,” Song asked the director of the Fed’s International Finance Division, Steven Kamin in the July 27 email.

Five hours after the request was received, Kamin emailed a 259-word summary to the PBOC on how the Fed worked to calm markets and prevent a recession after the S&P 500 stock index tumbled 20% on October 19, 1987.

“Kamin also sent notes to guide PBOC officials through the many dozens of pages of Fed transcripts, statements and reports that were attached to the email,” said Reuters.

In response to market rout, the PBOC, in conjunction with China’s stock market regulator, the CSRC, announced a wave of unprecedented measures to support the nation’s stock market in the weeks following the email exchange.

State-backed investors were forced to buy while others were prevented from selling. Some futures traders, suspected of “malicious short selling” by authorities, were even facing the prospect of being arrested for betting on further declines. Interest rates were cut as was the cash reserve requirement for banks.

Despite those efforts, and the advice from the Fed, China’s stock market rout only intensified in the months ahead, eventually seeing the market halve in value in the eight months to late February 2016.

While speculative buying fueled the boom and bust in both 1987 and 2015, there’s little doubt that expensive valuations, investor inexperience and the use of margin finance amplified the negative feedback loop seen in China’s market.

You can read more on Reuters remarkable story here.

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