Monday, January 5, 2015

Downward Price Rigidity

When input prices go up, like the not so distant fuel price increases, wholesale and retail prices usually go up, often quite disproportionately, namely, more than justifiable. However, when input prices go down, like recent fuel price cut, wholesale and retail prices do not come down at all. Why?

This is a common phenomenon known to economists as "downward price rigidity". It applies also to property prices, share prices and other prices as well.

Producers and suppliers are always testing the market to see how much the market can bear in terms of prices. This is when they can extract a surplus - which they will justify not in terms of the cost of production or normal profit but over and above those, in terms of the higher cost of living in general, the higher rental or prices they have to pay to own a property, etc.

The coffee shop owner is not going to cut his price for a cup of coffee if at the same price, the number of customers is the same. The customers may grumble but they will still pay for that cup of coffee, even if the strengthen of the coffee has already been weakened. The only coffee shop owner who will offer a lower price is the one who is not getting enough customers and is therefore quite happy to try to attract new customers will a lower price for a cup of coffee.

It is simply a case of the strength of the demand against the strength of the supply. Conceivably, it may be argued that, now that the price of petrol has been cut, the demand for coffee for in fact rise because consumers now have "spare cash" saved from the petrol to splurge on coffee.

In the case of property, as the banks now cut back on mortgage loans together with higher interest rates, we would naturally expect property prices to fall, now that there is an apparent decline in demand for property. But no current holder of property will sell at a price lower than the last transacted price unless he is desperate - in the sense of being threatened by the bank with bankruptcy or that the bank is in fact undertaking forced selling to recover their principal plus interest back. There is competition for banks to force sell if banks perceive the property market to be weak as a whole. But there is time to see a decline in property prices because the banks will take years from the start of the issue of the letter of demand for loan repayment to the borrowers to the time when the banks gets a judgement from the court to declare bankruptcy on the borrowers.

Furthermore, if there is a perceived decline in the property market in general, then property developers will also stop launching new projects. This will reduce the oversupply of new properties. But there will also be an oversupply in the existing property market, especially when speculators have already entered the market to bet on the further increase in property prices. Even if there are no new projects launched, there will also be new projects already launched and under construction and there will also be a string of new supplies coming into the market. It is likely that property prices will fall, but the pace will depend on institutional factors, like bank actions, court actions, government interventions, ability of owners to hold their properties.

The share market and the property market are quite similar in the sense that they are the playgrounds of the same group of people who speculate to make money. The ups and downs of the share prices are well know and they can adjust very fast. They can crash and pick up within a day or two. This is when the share market is fairly stable and there are no structural changes. However, the current situation is that with the end of the Quantitative Easing in the US after three long decades, there is now a major structural shift - that US interest rates will rise because the economy at long last is recovering. Hence, all US capital around the world will return to motherland. This flow back to the US equities market means an outflow of funds from overseas equities markets including Asia. The Asian stock markets crash. As local currencies are being converted to the US dollar for repatriation, local currencies weaken and the US dollar strengthens.

So far, the adjustments in the local stock market is without too much interventions. There is no panic even if the outflow is not small. There is no attempt at capital controls as happened in the late 1990s. Portfolio investors are allowed to freely sell in the local market and repatriate their funds. The only big worry now seems to be money laundering where illegal money go through the stock markets and are now being "repatriated" as the outflow of foreign indirect investments. This is where the central bank comes in to ask everybody to prove the source of the foreign remittances.

But there is always tendency to hinder market price adjustments especially when politics enter the economic picture. Politicians are quite happy to use public funds to support falling asset prices when the declining prices are destroying their financial positions. This is why downward price adjustments usually involve regime change, as is happening in China which is trying to get rid of the corruption that is embedded in the current system by previous regime. In the home front, there is a subtle attempt at engineering change of the system but that change is being made by creating a new one over the old while the old system is monopolising all major sectors of the economy. There is no more private sector.

The current attempt at teasing more cash from the general public through the GST (coming 1st April) is not a strategy for reducing local prices. But the sharp decline in the world price for crude oil is a major game changer. It is both a product of the US shale gas and the overall economic adjustment in China. If we are not looking at our economic prospects from the point of view of the world strategic situation, we are certainly not going to feel very smart staring straight into the depth of a coffee cup.


walla said...

Hopefully a stronger US dollar means higher demand for more exports from us.

However a weaker ringgit means capital goods needed to expand production to meet increased demand will cost more.

And wherever financing has been from overseas sources which is the case for the large enterprises, mayhem will be wrought on local cash-flows by the new monthly paybacks.

Some of these increased costs of financing and production will be passed on to local consumers since most local enterprises don't export exclusively but depend in the main on local business.

Meanwhile leave your surprise at the door. Some establishments have already implemented their version of 'GST'. They just call it 'government tax'. This trend will only pre-catalyze costs before April so that once GST kicks off, expect a slalom of runaway prices even as all goods and services are already now more costly although fuel costs are down.

One would have expected managing fuel prices shouldn't have to mean keeping them well above world market benchmarks with view to closing the ballooning deficits from politically-fixed poxy excesses of a few against the well-being of innocent millions.

Power IPPs must bring down electricity tariffs in line with the drop in fuel prices. Since they are computerized, bills can be auto-adjusted on their rates month to month.

In some places, those bills still show dues despite their having been settled earlier. Needless to say, anything is endlessly possible in this madcap dunder-headed country.

Which comes to the aftermath of the eastern seaboard floods. It will take at least five years to return some normalcy. Not just lives but also livelihoods are already lost. Not just homes, offices, factories, shops and sheds but also roads, rails, power-lines and reservoirs have been destroyed. It's total devastation.

Neither state nor federal government has any money for future flood mitigation or relief and most insurances don't cover force majeure even when we are led to believe it was an act of the One because huddud was not adopted.

If that be the case, can the same confirm by proxy there will be no future floods or fires or tsunami's or competing shale fracking if huddud is adopted? The answer is either a yes or a no. After all, true faith requires nothing in between. Maybe?

Clearly, if better preparations against future disasters are to be made, start with more critical thinking and common sense.

walla said...