Credit and Economic Expansion

Recently there's been a wave of attention around a motto: "do you #smallenfreuden?". This craze was later revealed to be the work of Visa, supporting their cashback rewards. The basic premise is that for every dollar you spend, you get some portion (normally less than 1 per cent) back, paid to you as a dividend at the end of the year.

You can watch a commercial for it here. There are numerous versions but the idea is the same. Don't just use your credit card for large purchases, use it even to buy a doughnut or a magazine. Credit card ownership now is very high, often with people holding two or more cards in their name. With markets saturated, Visa is looking for a new way to increase its bottom line. The next logical step is getting people to use plastic for a higher proportion of their purchases.

This comes in the wake of a significant credit bubble. I've already written about the credit crisis before. Rates of consumer debt are ridiculously high in North America, and for the first time Canadians are spending more money than they make. The average family spends $1.50 for every dollar they bring in. It's not a zero-sum game, like everyone has to be breaking even all the time, but the desired balance from a sustainability standpoint is that you can't always be spending more than you make. It just doesn't last.

Credit cards have been on the defensive over the past few years. Television shows have exposed the outrageous debt loads that average middle-income North Americans have amassed. While credit companies have at most only be partially blamed, there has been more attention paid now to the fact that credit cards are at least an enabler.

Companies like Visa are fighting back, however. And it certainly makes decent sense from their perspective. The psychological imperative is pretty compelling for the average consumer. You can make 1 per cent cash back over the year, which for some people may amount to saving 100 dollars. It's no different than loyalty programmes like Air Miles, Petro Points, or any other such systems. You are rewarded for spending money in a certain way and there's a small prize in it for your sustained attention. These programmes are popular because people want to get perks. As I'm writing this I'm very aware of the fact that I have cashback on my MasterCard.

Studies show that when we feel like we're working toward a reward we tend to make poor decisions. People will spend more thinking they'll get more points, but the logical is rather nonsensical. Spend ten dollars more to get ten cents back. Often people get prizes they wouldn't otherwise want, thoguh with cash that's never a problem. Nevertheless it works, and Visa is upping the ante by suggesting that you put virtually all your purchases on your credit card.

It may be worthwhile to say that I think there's lots of merit to buying with a credit card. It allows you to review your purchases and to keep records. It's convenient and you never need to carry lots of cash. However, the downside is that you're spending money that, in many cases, you don't have. More importantly, if you don't come up with that money you can face penalties of up to 28 per cent per year compounded monthly. In case you are curious about what your card can charge you, check out the details on the back of your statement; it's mandated by law that they explain how long it'll take to pay off your balance with minimum payments.

Credit cards are tools. Inherently neither good nor bad. But knowing how to use them is simply not a skill that many people have. Many of my friends and students don't know about the basic components of debt, financing, or interest. I was myself shocked to find out that when I paid my MasterCard bill I was short about 10 per cent of the total and they are legally allowed to charge me interest on the entire value of my balance carried. Unbelievable. I know the information is readily available you go online to find it, but that's often insufficient help for people.

While the effects for individuals are rather clear, the effects for the economy at large are shrouded. The historical context is very interesting: 1929 and 2007 are remarkably similar events. Cultures that were built on credit eventually must collapse. Massive economic growth in the 1920s was rather similar to the 2000s, financed on credit and overproduction. Year-over-year the economy expanded, largely because people bought stuff with money they didn't have, meaning that the economy was growing based on debt. Another way to look at that is that the economy grew based on future contraction, and looking at the 1930s and now it's rather evident that this was in fact the case. Both 1929 and 2007 were shocks were credit bubbles burst and suddenly the debt structures, like pyramid schemes, were unveiled. The speculation in the stock market during the 1920s led to extreme overvaluation and eventually collapse. Sub-prime mortgage lending in the 2000s brought the global economy to a standstill more recently.

Fundamentally, whether we like it or not, we are bound by the realities of economics. We can not borrow against the future in the long run. The current federal stimulus package (for which the millions of dollars of advertising has been allocated) is an example of this "spend our way out of trouble" philosophy. Creating growth without equality can function in the short term, as it has since the introduction of neoliberalism in the 1980s, but once the growth is gone, the inequality is exposed with real consequences. I sincerely believe that creating a more even economic climate will be the only real sustainable way forward.