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Colorado: The New Bull Market

Over the weekend, Ireland became the second Eurozone country to get a significant bailout from its neighbors in order to head off a large scale financial collapse. Yesterday, the President issued a two year wage freeze for all federal employees as a response to the continuing weakness in the economy. Unemployment has shown few signs of recovery, and the housing market continues to struggle. After some years of free spending, the world is now focused on deficits and debt reduction.

The Colorado Rockies, however, think everything is going to be just fine. That’s really the only conclusion you can draw from the decision to extend Troy Tulowitzki‘s contract through 2020. This contract isn’t really about the player, as much as it is a bet on significant inflation returning to baseball salaries.

The Rockies already had Tulowitzki signed for the next four years at a total cost of about $39 million, assuming that his 2014 option would have been exercised. This extension doesn’t alter those payments at all, so this was not a case of the Rockies adjusting Tulowitzki’s pay to reflect his strong performance. Instead, they simply guaranteed the option year and then added a six year extension to the end, totaling $119 million in new money.

$20 million a year for Tulowitzki’s age 30-35 seasons doesn’t sound too bad, given his broad base of skills and overall ability. Carl Crawford is going to get a similar contract this winter for approximately the same time frame of his career, and while they’re not the same player, they are both quality hitters who get a lot of their value from their defensive abilities. The difference, of course, is that we have far more information about what Crawford was at this age than we do about what Tulowitzki will be in four more years.

The Rockies have taken on a substantial amount of long term risk for the right to sign Tulowitzki to a deal that is close to current fair market value. The only way it makes sense to do that deal now is if we’re about to enter a four year period of significant inflation.

For instance, if we see 10 percent salary inflation over each of the next four winters, $20 million per year now would be equivalent to $29 million per year in 2015. Over a six year contract, this deal would be a $45 million savings over what they would have to pay Tulowitzki in that market, given that he had aged normally and was still perceived in exactly the same way.

10 percent yearly salary inflation is pretty aggressive, though – that is the kind of annual raise we saw during the dot com and housing bubbles, where spending exceeded rationality. If we lower than rate to 5 percent, then $20 million now is equivalent to $24 million in four years, and the Rockies would only be saving $24 million over a six year deal handed out when Tulowitzki became a free agent.

Given the timing of the contract, I have to think the Rockies are betting on annual inflation closer to 10 percent, because otherwise they’re simply inheriting a massive of risk without the necessary reward. Saving $4 or $5 million per season on a long term deal for Tulowitzki is nice, but it wouldn’t be enough to justify accepting the problems that could arise between now and 2014.

Are the Rockies right about inflation? Maybe, but based on what I know about projecting economic futures, they don’t have any way of knowing. This is essentially an expensive guess about where the market is going in a time when no one really knows where the markets are going.

Given that this is the same organization now suffering under the weight of an extension given to Todd Helton with a similar premise, and the team that had to pay a huge chunk of Mike Hampton‘s contract to unload him two years into an eight year contract, you would think a little more long term risk aversion would be in order. From where I sit, the Rockies just took on too much needless risk. This seems like a deal they should have sat on for another year at least.