If I understand this correctly, someone decided to create their own currency and its validity comes from other people buying into it and having confidence in it and being willing to both buy AND SELL stuff for BC rather than say, USD. The BC itself really has no value at all (neither do USD actually) unless people agree to exchange things for them. The "exchange rate" then is really a more or less arbitrary value based upon what people are willing to give up, sell or transfer for a BC. That is, the value of the currency is determined by the active market. So if someone decided they would sell 1000 dollar items for five BC each, and they did that for some time, the value of BC would be artificially inflated because people would expect to be able to get 200 dollars worth of merchandise for 1 BC. a 200:1 rate of exchange against the dollar. Meaning that if this someone had a buttload of BC in his wallet, he would be a BCillionaire in a heartbeat. Then he could dump his BC into the market by selling them to someone else for say 80% of the artificial value and go buy a private island while all the other people who were holding BC scrambled for redemption of their falling values. And since there is no central government behind BC, and no internet currency police, then there is no one to cry out to over the fraud. Is my understanding accurate?
Your analysis is incorrect because you have completely ignored the issue of market depth. You're assuming depth is zero on asks and infinite on bids (if this was the case, of course the price would easily go up).
If someone were to sell $500 items for 1 BTC each (I'm using different numbers, because your numbers implied a BTC value which is actually lower than what it is currently), and even if these items are completely liquid, this will not raise the BTC price to $500. Rather, people will buy bitcoins on the open market, and use them to buy from this person at profit, until he runs out of items to sell. This will increase the price, but not up to $500.
Whatever the new price is, the person can't just sell all his bitcoins at this price. The market only has limited depth, so if he starts selling large amounts of bitcoins the price will drop, even below what it was originally. In all likelihood, the person will just end up with a loss after all these games (because he sold items at a loss, and then suffered slippage from trying to dump everything at once).
Of course, that's not different from any other market. What keeps these things from happening is economics, not regulation.
To say what Meni said a slightly different way -- a market is going to have natural supply and natural demand and this will form a natural price. You can try to manipulate the market by creating the illusion of extra supply or extra demand to make the price higher or lower.
But the problem is that the further you try to push the price from the natural price, the more it costs you to do it. To keep pushing the price up, you have to keep buying at the artificially inflated price you've created. You have to take bigger and bigger losses to achieve smaller and smaller changes in price. And the second you start selling, the price will fall like a rock. It's virtually impossible to make up the losses.
The other problem is that a manipulator must pay the full costs of his manipulation. But he must share the profits with anyone else who wishes to trade on the market. If you manipulate the price up, I will sell too. If you manipulate the price down, I will buy too. So while you bear all the costs, good luck getting even a significant share of the profits.
Many people have made the mistake of thinking that you can push a price up or down and then profit from trading at the artificial price. It's not impossible to do so, but you can't reliably do it just by ordinary buying and selling. There are many people who have tried to do so and lost huge amounts of money.