If someone is belived to have become a god by enough people, over time this will be truth. Alteration is all about beliving the laws of the world are different then they are, so does this mean that someone skilled in Alteration is just someone who knows how to manipulate this rule to their own ends?

Well, kinda.

Alteration does have to do with the manipulation of the laws of nature, or Earthbones.

http://www.uesp.net/wiki/Morrowind:Breathing_Water is a good book on this, interesting story too.