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posted on 02 December 2015

What Science Does Economics Most Closely Resemble?

by Rodger Malcolm Mitchell, www.nofica.com

In your opinion, which scientist is best equipped to understand economics:

  1. A physicist?

  2. A mathematician?

  3. A psychologist?

  4. A chemist?

Choose one.

Personally, I would choose the psychologist, because economics essentially is psychology.

While physics, mathematics and chemistry rely on specific, proven, reproducible relationships, economics almost wholly is arbitrary and subjective.

I'll give you a painful example.

Commodity pricing is a function of economics. Years ago, I owned a commodity brokerage, where we employed a prize-winning chartist. (I can't recall the name of the contest he won, but he and all the other entrants had to use charting techniques to predict various commodity prices.)

When we discussed his system, he spoke very authoritatively of "support levels," "trend lines," "resistance," etc., all under the name, "technical analysis," and it all sounded quite scientific.

Here is what stockcharts.com says:

Support is the price level at which demand is thought to be strong enough to prevent the price from declining further. The logic dictates that as the price declines towards support and gets cheaper, buyers become more inclined to buy and sellers become less inclined to sell. By the time the price reaches the support level, it is believed that demand will overcome supply and prevent the price from falling below support.

Amazon.com, Inc. (AMZN) Support and Resistance example chart from StockCharts.com

Support does not always hold and a break below support signals that the bears have won out over the bulls.

A decline below support indicates a new willingness to sell and/or a lack of incentive to buy.

Support breaks and new lows signal that sellers have reduced their expectations and are willing sell at even lower prices.

In addition, buyers could not be coerced into buying until prices declined below support or below the previous low. Once support is broken, another support level will have to be established at a lower level.

If you detect the faint aroma of bovine excrement, I don't blame you. In essence "support" is an arbitrary line, meaning nothing.

Charting, as a means to predict commodity prices, works sometimes and doesn't work sometimes. In other words: It doesn't work.

So sadly, our prize-winning chartist later proved spectacularly unsuccessful in predicting prices in the real world, and those of our customers who relied on his prognostications lost money.

Charting still is widely used as a predictive commodity pricing tool.

The use of charts to predict economic events is typical of economics as a science, because we economists have the compulsive urge to prove we are "real scientists," and as "everyone knows," real scientists base their hypotheses on mathematics, especially graphs.

I do it. We all do it. But that doesn't make it smell any better.

The problem, of course, is that economics is a reflection of human psychology. Even worse (i.e. more deceiving) is the fact that economics also is a reflection of real physical processes. It's a blend.

Consider what might be the most basic equation in all of economics: Value = Demand / Supply.

It says that increased Demand and/or decreased Supply (scarcity) increases Value (as measured by price). Intuitively logical.

Value, though, is complex. What is the price of a TV set? The answer depends on many variables: Size, model, manufacturer, retailer, location, date.

And Supply is equally complex. It too depends on those variables.

But ultimately, one can measure Supply and Price. They are finite. You can walk into a store and see that the store has three of a specific item at a specific price.

But how does one measure Demand?

While Value (price) and Supply can be set arbitrarily, Demand cannot.

Demand is related to motivation, which is buried in the human psyche. How do you measure a population's motivation to buy a Porche, a pansy or a pickle? You only can do it derivatively and approximately.

That is, when economists know the Price and the Supply, they can derive the approximate Demand. But, if they don't know both the Price and the Supply, they cannot know or determine the Demand.

The inherent weakness of the equation Value = Demand/Supply, applies to most equations in economics. They are ruled by the variables of human psychology.

At the bottom of this post is a graph indicating that reductions in federal deficit spending lead to recessions.

It is not like a graph that shows, for instance, the relationships among distance, time and speed (Distance = Time x Speed). They are not functions of psychology. Each can be stated with exact precision.

The graph at the bottom of this page encompasses thousands, no trillions, of human actions and decisions, which unless you believe in determinism and not in free will, are beyond measure and prediction.

Thus, my chartist employee's efforts to predict commodity prices were doomed from the beginning. Unpredictable and unmeasurable factors affected the outcome.

In most nations, and surely in America, the single biggest unpredictable economics factor is actions by the central government.

Will it create a war? Change interest rates? Deficit spend? Allow or reject immigrants? Allow or prevent the use of resources? Almost anything the central government does affects the economy.

The government is composed of human beings, each of whom is affected by other human beings, as well as being affected by health, weather, threats, anticipated and unanticipated events, fear, hope, greed - the list goes on and on.

The graph (below) indicates we have come dangerously (and unnecessarily) close to recession. But when people ask me, "When will we have the next recession?" my answer always is, "Tell me what the federal government will do, and I'll tell you when we'll have the next recession."

Compare that vague answer with the specific answer a physicist will give you if you ask him how long it will take a photon to travel a mile, or a mathematician will give you if you ask a question about set theory.

I suspect a physicist, a mathematician or a chemist would become exasperated with the pretensions of economists.

Look in any economics textbook and you will see it is loaded with graphs and formulas, almost none of which are more than approximations, and usually less, but appearing to be much more.

If I tell you reductions in federal deficit spending lead to recessions and depressions, that statement is about as accurate as economics can be. There is no formula, no proof, that can improve on that statement for accuracy.

I can show you the many times when reductions in federal deficit spending did, in fact, lead to recessions and depressions. But repetition is not scientific proof. Physicists know that.

I have awakened 30,000 consecutive mornings, but even that massive repetition does not prove I always will awaken.

And if someone presents exceptions showing how at certain times, reductions in federal deficit spending did not lead to recessions and depressions, they merely are expressing the variables of human psychology. They neither have proved nor disproved anything.

That is the point of this blog. Economics tries to be - pretends to be - something it is not, and probably never will be: An exact science.

At best, economics is equal to psychology in its accuracy of prediction.

So where does that leave us? Is all useless? Is it fruitless to predict that A - > B? Are we lost in randomness?

Not at all. We still can learn from facts, logic and experience.

Consider federal debt. The politicians, media and economists stress about it, and claim it is similar to personal debt, and is "unsustainable." But what are the facts?

Federal debt is the total of T-securities outstanding. That is a fact.

Federal agencies own some T-securities. But most are owned by people, businesses or governments other than U.S. federal government.

To acquire a T-security, one must debit a bank checking account and credit a T-security account at the Federal Reserve Bank. T-securities are bank deposits - deposits in accounts in the FRB.

To "pay off" ​a T-security, the Federal Reserve Bank debits the appropriate T-security account and credits a checking account. This is identical to what any bank does to pay off any savings account.

Those all are facts.

Logically then, since the Federal Reserve Bank pays off federal debt with dollars that already exist in T-security accounts, the federal debt never can be "unsustainable."

And, our experience is that the U.S. government never has defaulted (i.e. not "sustained") on its debts - not through recessions, depressions, wars, inflations, deflations or natural disasters.

Does any of this scientifically prove the federal debt always is and will be sustainable? No.

I can visualize scenarios in which the government might default - for instance, Sen. Ted Cruz becoming President.

Because economics is akin to psychology, strict proof of anything is rare. But using our prime tools - facts, logic and experience - we can approach predictability, the goal of any science.

Unfortunately, economists have shunned facts, logic and experience, in favor of abstruse mathematical formulas, to "prove" the unprovable.

Economics and psychology may never have the accuracy of physics, mathematics or chemistry. In striving for that exactitude, economists peer deeper and deeper into minutia, while losing the big picture and the fundamental facts, logic and experience.

(How else can one explain the widespread misunderstanding, within the economics community, of federal debt, deficits and money creation?)

Economics essentially is a "soft" science, like psychology or philosophy. In trying to be part of a "hard" science, economists have gone astray, and done a great disservice to the public, the nation and themselves.

It's time to get real, economists.

No nation can tax itself into prosperity, nor grow without money growth. Monetary Sovereignty: Cutting federal deficits to grow the economy is like applying leeches to cure anemia.

  1. A growing economy requires a growing supply of dollars (GDP=Federal Spending + Non-federal Spending + Net Exports)

  2. All deficit spending grows the supply of dollars

  3. The limit to federal deficit spending is an inflation that cannot be cured with interest rate control.

  4. The limit to non-federal deficit spending is the ability to borrow.

THE RECESSION CLOCK

Monetary Sovereignty

Vertical gray bars mark recessions. Recessions come after the blue line drops below zero and when deficit growth declines.

As the federal deficit growth lines drop, we approach recessions, each of which has been cured only when the growth lines rose.

Increasing federal deficit growth (aka "stimulus") is necessary for long-term economic growth.

Mitchell's laws:

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