Stock Market Meltdown: China Central Bank Sought Help from Fed

Reuters recently obtained through the Freedom of Information Act an email from the People’s Bank of China’s (PBOC) chief representative for the Americas, Song Xiangyan, to the director of the US Federal Reserve's International Finance Division, Steven Kamin, on the morning of July 27, 2015. 

The email, which had the subject line: "Your urgent assistance is greatly appreciated!" sought help from the Fed, which had experience in dealing with the 1987 New York stock market crash. Earlier that day, Chinese stocks had dropped 8.5 percent, which was the biggest one-day fall since 2007.

Mr Kemin obliged five hours later with a 259-word summary of how the Fed worked to calm markets and prevented a recession after the S&P 500 stock index tumbled 20 percent on October 19, 1987. He 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. Mr. Kamin pointed out in his email that everything he was sending was publicly available and he hoped that the information would be helpful.

All of the attached documents had long been available on the Fed's website and it is unclear if they played a role in any subsequent PBOC actions. However, the market dropped another 20 percent in August following the PBOC’s August 11 decision to allow RMB to depreciate 1.9 percent.

The episode highlights several interesting lessons with regard to financial market crisis handling:

(1) There is no standard playbook in dealing with crisis, and the Fed can only provide publicly known information without any assurance of whether it will work or not. Earlier policy success in the financial market is at best a guidepost in dealing with the next crisis, and any idea of using yesterday’s success to control today’s crisis is at best the scientific equivalent of forecasting yesterday’s weather. 

(2) The financial markets can be irrational at times and governments should always be alerted to such a possibility, and they should draw on similar crises in the past with a view that combinations of tools drawn from different incidents might work. 

(3) Financial market connectivity nowadays is high and very unpredictable. The Fed’s provision of liquidity to stabilize the market worked in 1987 and there was no spillover effect from said policy to other markets. In the Chinese meltdown of 2015, the subsequent PBoC decision to trade RMB in a wider band on August 11 triggered another 20 percent drop in Chinese stocks, fueling fears of a global currency war. Introducing new policies in financial areas at a time of high volatility always runs the risk of misinterpretation by the market and can trigger other crises.