As you know, I often comment on China.

Because China is critical at the steakhouse – I mean, if we didn’t have china, how could the restaurant serve that piping-hot Porterhouse to your table?  Right?   Or your Beef Carpaccio?   Lobster Mac & Cheese?   Paper plates?   NOT a chance!

OK…ok…bad joke.   I’m not talking about THAT china!  🙂

China’s massive US dollar reserves have fallen below $3 trillion for the first time in 6 years.   Since peaking in June of 2014 over $4 trillion, more than $1 trillion has left the country.  Note this is greater than 25% in just a bit over 2 1/2 years!  Why has this happened?  Why should we care?   And what does it mean?

Welcome to this week’s Steak House Index update.

 Remember to view the SHI on its very own URL – https://www.steakhouseindex.com/     The reading experience on the site is much better!

As always, if you need a refresher on the SHI, or its objective and methodology, I suggest you open and read the original BLOG: https://terryliebman.wordpress.com/2016/03/02/move-over-big-mac-index-here-comes-the-steak-house-index/)

Why You Should Care: The US economy and US dollar are the foundation of global economics: our nominal GDP is over $18.8 trillion a year. Is it growing or shrinking? Is it possible to know – before the quarterly GDP releases from the BEA?

The objective of the SHI is simple: To predict the GDP direction ahead of official economic releases. But while the objective is simple, the task is not.

BEA publishes GDP figures the instant they’re available. Unfortunately, it is a trailing index. The data is old news; it’s a lagging indicator.

‘Personal consumption expenditures,’ or PCE, is the single largest component of the GDP. In fact, the majority of all GDP increases (or declines) usually result from (increases or decreases in) consumer spending. Thus, this is clearly an important metric to track.

I intend the SHI is to be predictive, anticipating where the economy is going – not where it’s been. Thereby giving us the ability to take action early. Not when it’s too late.

Taking action: Keep up with this weekly BLOG update. If the SHI index moves appreciably – either showing massive improvement or significant declines – indicating expanding economic strength or a potential recession, we’ll discuss possible actions at that time.

The BLOG:    US dollars are leaking out of China.   After building up a massive USD surplus since 1994 …

… the current trend is in the opposite direction.  Why?

Well, in a nutshell, Chinese nationals are moving their domestic currency holdings (the yuan) out of the country, predominantly into USD.   Either by depositing funds into a US bank … or by purchasing US assets.  In either case, the US holder of (recipient of) yuan then demands China convert the yuan they possess into USD.   Thus, China receives the yuan and, in exchange, the US holder receives USD.

For years, the flow worked in the opposite direction as China built up their huge stockpile of USD.   As the beneficiaries of a huge US trade deficit (for China, a huge trade surplus) they retained the USD they received for their goods exported to the US.   Of course, that surplus continues today, but their stockpile is shrinking.  Quickly.   Why?

Exchange rates AND fear.

Take a look at this chart:

Both lines are “index” lines where January of 2012 = 100.  The BLUE line reflects the same data as the first chart – but, remember, it’s an index chart.   So, in January of 2012, the index value of “Total Reserves” equaled 100 … then in June of 2014, the index value was about 122 … and in January of 2017, about 92.

The RED line shows the USD/Yuan exchange rate.  But I’ve modified the line to its inverse – so we can see how exchange rate movement is correlated with the decline in USD reserves.   

What’s more, once this problem develops it usually gets worse.  Fear of further devaluation drives citizens to export more currency … which drives further devaluation … etc., etc., etc.  Imagine a small pin-prick hole in a balloon.  Once the air begins to leak out … the rate usually increases over time.   Regardless, the balloon deflates.

China is reacting in fear:   They have implemented “capital controls” to stem the flow … to plug the leak, so to speak.   Of course, in public they deny higher hurdles for individual FX and Chinese companies making international acquisitions.   Pan Gongsheng, a deputy governor of the People’s Bank of China, described the recent tightening primarily as an effort to close loopholes and improve enforcement of existing rules and root out fraud.   Not to restrict capital flows.   OK….right.

I don’t believe him.  Nor do many Chinese citizens.  Which is easy to see in the chart above.  They are moving money out of the country.  If this trend accelerates, it could destabilize the country or foster a huge inflation increase.    As China has the 2nd largest GDP on the planet, both would have massive implications to our economy.  We will continue to watch.  Right now, China has about $3 trillion in USD reserves.   We’ll come back to this topic if change accelerates.

Shall we move on and see if Mastros ‘Ocean Club’ is once again fully booked?

Yep…it sure is!    And look at that:  The Capital Grille is unavailable at 6:00 pm!   Impressive!  🙂

Pricey steak-house reservations continue to be in vogue.  The SHI, as our proxy for consumer spending, is reflecting continued robust consumer demand.   We now have a full year of data.   As you can see below, we began tracking the SHI on 3/2/16 … and today being 3/1/17, a full year is behind us.    The reading today, at a positive 6, is not meaningfully different than one year ago.   Take a look:

It is interesting to note the BEA released its “Personal Income and Outlays, January 2017” report this morning.   In this report, the BEA shares recent developments in income, consumption and the PCE (the index the FED and Terry Liebman prefer when tracking inflation movement.)   Here are the data:

Take a look at the “Personal consumption expenditures” figure above for January:  A 0.2% increase over December.   With 5 months of data in the chart above, we see this reading is at the low end of the range.   Suggesting consumption may be trailing off somewhat.  Of course, our SHI disagrees.   Consumption is steady.

The PCE figure above is definitely suggesting the inflation rate is approaching the FEDs 2% target.   With a YOY increase of 1.9% (and a 1.7% ‘core’ figure), when combined with the strong employment marketplace,  I suspect the FED now has the ammunition to support a March rate increase.    Expect one.

This notwithstanding, our economy remains in a good place.  The US expansion continues.

• Terry Liebman