Friday, July 19, 2013

Is Economics a science or religion? Religion.

In his Bloomberg column, Mark Buchanan asks a terrific question: is economics a science or religion.

Science is based on facts.  Theories are proven or disproven based on their ability to explain all the facts.

Religion, on the other hand, allows you to believe something in the absence of any supporting facts.

A strong case can be made that economics is a religion based on the unwillingness of economic professionals to actually look at the facts.

The unwillingness to consider inconvenient facts isn't surprising as the standard economic analysis starts off by making a series of assumptions.  Assumptions that the economic professionals consider so basic that they don't bear repeating.

Unfortunately, they are assumptions that the facts frequently show to be wrong.

For example, the economics community has championed the call for banks to hold more capital.  The core argument that the economists make is that if banks have a higher level of book capital, this will reduce if not eliminate the amount of or need for a taxpayer bailout.

On the surface, this argument seems perfectly reasonable.  By definition, if the bank has a higher level of book capital, it has a greater capacity to absorb losses before it reduces its book capital to a level where it presumably needs to be bailed out.

However, if we scratch the surface, we find out that this argument has several assumptions embedded within it.  The first of these embedded assumptions being that regulators will require banks to recognize their losses upfront and not protect bank book capital levels out of fear for the safety and soundness of the financial system.

But is there any evidence to support this embedded assumption.  If we look at the US Savings and Loan crisis, the answer is no.  If we look at our current global financial crisis, the answer is no.

There is absolutely no evidence on a global basis that regulators will require banks to recognize the losses hidden on and off their balance sheets.

Instead, as the Bank of England's Andrew Haldane elegantly said it, there is evidence that regulators have an irresistible urge to bailout the banks.


Believing that banks holding higher levels of capital won't need to be bailed out or require as large a bailout is simply a religious belief as there are no facts to support it.

Hence, the observation that economics is a religion.

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