13 - Credit cards
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Key points:
Credit cards can be dangerous. You should use them thoughtfully and with purpose. If you notice that you aren’t sticking to a budget, taking the credit cards out of your wallet might solve problems.
Credit cards come with challenges for society. It’s worth questioning whether or not you want to be a part of that system.
Only 30 companies in the United States bring in as much revenue as credit cards cost Americans each year. They are an absolutely massive industry.
Credit has been around since ancient times. Farmers needed credit in order to plant crops because the seed and tools needed to plant required capital but the capital would only be available once the harvest had happened. This is a basic form of credit, but the modern invention of credit cards allow anyone with a good credit score to spend capital now and pay it back (with interest). The history of credit cards is actually pretty interesting, The first instance of credit card being mentioned comes from Edward Bellemy’s book Looking Backward, originally published in 1887. The book described society in the year 2000, and the term “credit card” was used eleven times. It was used to describe a card that allowed citizens to spend a dividend from the government, the use is a bit different than how we think of credit cards today.
The first financial product resembling a credit card was called a "charge card” and they were made of celluloid which is an early type of plastic in conjunction with a range of other metals. This system evolved into the Charga-Plate, which was developed in 1928 and came in a form similar to US military dog tags.
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The plate had the customer’s name, city, and state on it, and when a purchase was made an imprinter pressed the tag onto a paper which included a place for a signature.
Airlines then played a role in introducing credit cards into American society. In 1934 American Airlines and the Air Transport Association introduced the Air Travel Card. This created a numbering scheme that identified the issuer of the card as well as the customer account. Modern universal air travel plans still start with the number 1 for this reason. This credit card gave users a 15% discount on any airlines that accepted the card. By 1941, half of airline revenue came from these air travel cards. This foreshadowed their economic value.
Next came Ralph Schneider and Frank McNamara who founded the Diners Club in 1950. The story goes that Frank McNamara was at dinner one night and when the bill came due he realized he left his cash in another coat pocket. His wife ended up having to pay for his meal which embarrased him. McNamara and Schneider created the Diners Club which allowed for paying for meals on credit, ensuring that McNamara wouldn’t be embarrased again. The club consolidated multiple cards into a single card and it had to be paid off each statement.
Each of these events moved us closer to a modern day credit card, but they were just feeling around at the edges of what would eventually become one of the most successful and lucrative financial products ever created. Initial cards never took off because of a lack of network effects, meaning that not enough customers had these cards to encourage adoption by stores, meaning not enough stores accepted these cards to make them enticing to customers.
In 1958, Bank of America launched the BankAmericard in Fresno, California which is credited as the first modern credit card. Bank of America chose Fresno because about 45% of the city used the bank, and when BofA sent the cards to 60,000 customers in the city, it started to make sense for merchants to adopt these cards as well. Fast forward to today and more than 80% of US adults use a credit card. We are even nearing the point where we don’t even need plastic. Credit cards are more and more going digital. This is a prime example of network effects.
Banks couldn’t be happier since they’re a great source of income. Banks make money from credit card holders by charging them interest and fees. Here is a list of all of the ways credit card companies make thier money:
Membership fees
Cash advances and convenience cheques, which can be around 3% of the total amount
Charges for exceeding the credit limit
Exchange rate loading fees for converting currencies
Late or overdue payments
Payment processing fees
Interest
This causes some societal problems. A 2022 paper by Agarwal, Presbitero, Silva, and Wix finds that rewards from credit cards likely facilitate a $15 billion wealth transfer from poorer, less educated, and minority groups to richer and more educated demographics, serving to increase wealth disparities. The paper posits that savy credit card consumers reap benefits from the card without incurring the costs because they pay on time, while unsophisticated credit card users often get lured into great reward programs and instead rack up significant interest charges and debt. Additionally, a meta analysis of four papers from 2010 indicates that consumers that use credit cards are more likely to purchase unhealthy food. The rationale is that unhealthy food is often an impulse purchase which is sometimes controlled by the pain of spending cash, whereas spending on a credit card is far more comfortable, allowing for more of those purchases.
Part of the issue is that credit cards actually activate reward centers within the brain which encourage spending. These reward centers are in the same structure of the brain that lights up when using drugs like cocaine and methamphetamine. The same mechanism is exploited by casinos and social media platforms to increase user engagement (and their sales). The perils of social media are coming to light as we learn more information about how big tech firms use data to increase time spent on applications, and the same tools can be used by financial institutions in order to increase spending and reinforce negative consumer habits. Financial institutions have vast information on consumers in 2023, and consumers should be aware that financial institutions can turn subtle levers to increase spending on credit cards.
In fact, in a 2019 study, researchers conducted a study including 16 healthy individuals, 50% male and 50% female. They showed these volunteers videos of people paying with cash, a card, or a phone during an fMRI. Regions of the brain associated with negative emotion were more active during videos of people paying with cash, indicating that consumers paying with card and phone feel less of the pain of parting with money. It’s important to point out that the study didn’t differentiate between credit or debit cards though.
Unfortunately, the solution probably isn’t more education. Increased financial literacy seems to put people at an even greater risk of mismanaging credit cards. In a 2013 paper published by a professor in the department of consumer sciences at the University of Alabama analyzed survey data from 6,520 students at a large Midwestern University. Findings indicated that financial literacy did not predict whether or not students had a credit card, but even more fascinating was that higher levels of financial literacy predicted higher credit card balances. This could indicate that the concepts we are currently teaching under the banner of “financial literacy” may need to be addressed.
The problem with credit cards is that, when used responsibly, they provide greater convenience, come with other benefits and rewards, and are a standard practice for most U.S. households. This makes it hard to rail too strongly against them, but there are clearly some reasons to be concerned. Credit cards are to the financial benefit of banks in aggregate, not consumers. The CFPB estimated that between 2018 and 2020, credit card holders paid about $120 billion in interest and fees. That represents about $1,000 per year per American household. To put that in perspective, Meta (Facebook), Johnson & Johnson, Dell, Tesla, FedEx, Pepsi, and Disney all make less than $120 billion per year in sales. In fact, there are only 30 companies in the United States that make more than $120 billion in sales annually. Credit card holders should always contextualize the benefits they receive from banks in this way. Credit cards can do a significant amount of damage to spenders that misuse them, and I think consumers should really ask themselves if they even need a credit card. Even if you pay your credit card off every statement, you’re still likely spending more than you would rationally do so without a credit card.
Our financial ecosystem doesn’t make it easy to quit credit cards. Rental cars and hotels still often require a credit card as collateral. Also, when you close credit cards, your credit score will take a short term hit. And while getting a mortgage on a home is generally a sound financial decision (assuming you’re not buying too much house relative to your income), getting a mortgage with a low credit score can be extremely difficult or expensive. If you’re running into spending issues you should probably keep your credit card out of your wallet, but don’t close your account. This will help to build credit history which supports your credit score. At the end of the day, think deeply and ask yourself if having a credit card is helping you to take a step forward, or enabling poor decisions that you might come to regret.
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