Saturday, March 28, 2009

Calgary Deflationary Scenario

I've been really busy with work and haven't had opportunity to post. This post from RJT deserves more attention as it presents a hypothetical scenario which is now becoming more realistic to a lot of people in Alberta. Before this is all over, expectations of a lot of people will change- annual raises, retention bonuses, competing offers, wage inflation will have become a distant memory. Keep an eye on the natural gas price, if it goes below $3, it will get ugly here.


For fun, I would like to give a hypothetical example of deflation in action:

Let's take your typical youngish, Calgary engineer. He's been out of school about 4 or 5 years, and so has only ever seen good times, and doesn't have a concept of what "normal" or "recession" is. Let's call him "Radley", just for fun.

Radley, has done very well for a young man. Graduating during good times, he made 65K right out of school. Within 5 years, he got some good raises and perhaps a promotion or two, and is soon earning 120K. Radley thinks this progression is "normal" in a city like Calgary, which is basically immune to the booms and busts of the rest of the world.

Problem is, the bust comes unexpectedly, and everyone around Radley, including his engineering bosses, comfort him by assuring him it is simply a 6 or 12 month lull, before the perma-boom resumes. His boss even gives him a nice big "retention bonus" around Christmas.

But then something happens. The company that Radley works for starts losing contracts, and those that continue to hire the company, are asking for a reduction in price. Company starts with a "hiring freeze". After a few months, the company realizes that the next few years, probably won't look like the past few, and they need to reduce costs to stay in business. The best way to reduce costs is to either lay off engineers. If they need to hire again in a year or two, it is much cheaper to hire a young one for 60K, than one for 120K.

Some engineers get laid off, and look for other work. They can get it, but the problem is it pays them only 80K, instead of the 120K they were used to.

This is deflation in action. It is happening all around.

This actual wage deflation, memory of wage deflation, and fear of wage deflation is what takes all of the heat out of the local RE market. People don't want to over-leverage anymore, even with interest rates at rock bottom. Better to be safe. Better to have savings (not tied up in illiquid assets). Better to live in a smaller house.

It is a fundamental change in the way people act, spend, and behave.

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