With China’s violent stock market volatility characterizing the last year, the People’s Bank of China (PBOC) did something highly unusual and seemingly unthinkable—they emailed the U.S. Federal Reserve for advice.
Last July, the PBOC’s chief, Song Xiangyan, requested the Fed share with China their playbook for Wall Street’s 1987 “Black Monday” crash. Xiangyan even asked for the information as soon as possible. The Fed responded promptly stating they would put something together.
The email came in July of 2015 when the Chinese stock market (Shanghai Composite) tumbled from 5,166 to 3,507 in just 30 trading sessions. This occurred after their rally of more than 150% in the preceding 12 months.
As the Chinese stock market continued to tumble with losses running in the billions, and markets consequently plunging all over the world, many termed this crash “China’s Black Monday,” in reference to the well-known crash of 1987. The Shanghai Composite closed the month of July with a 15% decline, making it the worst month for the Chinese stock market since 2009.
Given China’s level of pride and their desire to overtake the U.S. as a global economic superpower, their decision to reach out was surprising to say the least. But, it also speaks to just how fearful Chinese leaders were in the midst of the crisis.
So, What Advice Did the Fed Have About 1987?
You might remember it as “Black Monday,” but October 19, 1987 marked the largest one-day market crash in history. The Dow Jones lost nearly $500 billion dollars or 22.6% of its value in a matter of just few hours.
However, the Fed arguably handled the stock plunge well enough to calm the markets and prevent the economy from entering another recession or sustained bear market. In an attempt to arrest the market declines, and prevent spill-over to the broader economy, the Fed issued a statement the following morning indicating that it would support market liquidity. This was later referred to by many as “the most calming thing that was said,” considering the turbulent scenario. It was also one of the key catalysts contributing to the market rebound that morning.
The Fed also cut the federal-funds rate from 7.5% to 7%, hoping to attract more borrowers and in turn inject liquidity in the market. Additionally, they pumped-in reserves for the next several weeks, and worked with the banks and securities firms encouraging them to further extend credit to brokers and dealers to support their liquidity and funding needs.
The Fed’s experience then proved helpful—five hours after receiving the email request from the PBOC, the Fed emailed a 259-word summary to the PBOC on how they worked to calm markets and prevent a recession.
Bottom Line for Investors
It is generally better when central banks cooperate versus not—it sends a message to global markets that the largest economies are working together to create expansionary policy and liquidity when it’s most needed. Credit markets and stock markets alike see value in such collaboration.