THE pricing mechanism is the most basic part of an economy. William Shaw, a professor and former chairman of the Philosophy Department at San Jose State University in the US, describes it this way in his book, Business Ethics: It is “the manner in which the prices of commodities affect the demand and supply of goods and services. Price mechanism affects both buyers and sellers who negotiate prices of goods or services.”
The pricing mechanism includes the law of supply and demand whereby increased demand increases prices and increased supply theoretically lowers prices. But other factors are equally important.
The quality of a product will help determine price. An electric hot water pot that never reaches boiling temperature might sell only if the price were low enough to attract buyers who were not concerned with having boiling temperature water. A shirt made with fabric that irritates your skin might never sell no matter how low the price is dropped. Consumer preference plays a major part in the pricing mechanism where one color sells well in one year and is
ignored in another.
However, as long as both sellers and buyers are able to freely negotiate the price, the flow of goods and services functions pretty well without constant shortages or over-supply. The price mechanism clears the market.
But we have seen constant reminders that interference in the pricing mechanism causes disruptions of supply. Venezuela has been facing constant shortages of basic goods as government determines the price outside of production costs. A producer will not produce if prices cannot at least cover production costs. Yet, the Venezuelan government has mandated prices at or below the cost of production and then cannot figure out why there are not any goods available in the market.
The communist governments of the 20th century attempted central planning of both production and price and failed miserably. Yet the so-called free market capitalist nations of the 21st century did not learn any lessons from that failure.
Governments and central banks have attempted to move the asset and financial markets and prices in the direction they have wanted them to go. This has been done through intervention and outright manipulation. When the US government decided that everyone should be able to buy a home, the loans for purchases were guaranteed by the government regardless that many of the borrowers would never have the financial capability to repay the debt. Creating artificial demand this way also raised the prices of homes far beyond the normal boundaries of the price mechanism and the inevitable crash occurred.
The same process is being used in the financial and equity markets. We constantly hear that the Philippine Stock Exchange it too expensive in relation to other regional markets. I would contend the opposite. The regional markets are too cheap in relation to the Philippine Stock Exchange.
The ‘experts’ tend to benchmark stock markets by those that are being fueled by the interference of artificial non-market driven interest rates set by the central banks. In the Philippines we have a stock market driven by actual productive economic activity, growing corporate profits, and market based interest rates.
The pricing mechanism in a free and unmanipulated environment has priced the Philippine Composite Index at 7,600. Further it is not cheap credit foreign money that is driving prices higher. We know foreigners were selling in the fourth quarter of 2014 and still at the beginning of the year.
I argue that investors are properly pricing the PSE. Perhaps conditions are so bad in the other nations that their markets should be lower. But do not criticize or scorn the PSE for being priced at a level that the buyers and sellers freely agree upon. That is the way an efficient and effective stock market or any other good or service is supposed to work.
The negotiation between buyers and sellers based on both supply and demand is what the pricing mechanism is all about. When outside forces interfere, then both parties cannot realistically set a price. The US Federal Reserve and government says stock prices should be higher and then provides the money to buy and then prices magically go up. That is a market that may be too expensive.
A stock market where hard earned cash is taken out of pocket to buy stocks is a market that is fairly valued and fairly priced. That is the Philippine stock market.
E-mail me at mangun@gmail.com. Visit my web site at www.mangunonmarkets.com. Follow me on Twitter
@mangunonmarkets. PSE stock-market information and technical analysis tools provided by the COL Financial Group Inc.
2 comments
Very well said, John! See you at 10,000 then.
well said 🙂