Before there was money, there was credit.
Probably. Records are sketchy but it’s likely that, back when barter was the only method of exchange, before a common currency like wampum, clamshells, silver, gold, or paper gained “currency,” a Mongolian tribesman meeting a Chinese farmer in October for the twentieth time in twenty years might propose something like the following:
“Look, Friend, every time I need wheat for the winter I bring you a pony, right? Well, this year both our extra ponies were killed by wolves. I still need your grain or my family will starve. I have a cousin who has an extra pony. He owes me a favor so I’ve sent one of my brothers to fetch that pony. Howzabout you give me the grain – you know I’m good for it and my brothers and sons will repay you even if I die – and I’ll bring you the pony next spring and a bucket of yak milk just ‘cause you’re a good guy to help me out.”
Voila. Credit is born.
Credit cards, however, took a little longer. After people got tired (literally) from carrying 280 silver coins around, the Chinese invented paper money. And after people got tired of carrying around all that paper money, somebody started issuing a way to pay bills without carrying cash. I say “somebody” because, while a number of references to credit cards have been made as far back as 1890 in Europe, the use of what we think of today as “credit cards” began in the U.S. during the 1920s, when various department stores, oil firms and hotel companies began issuing them to their best customers. But these first credit cards only allowed for sales between the merchant offering the credit card and their existing customer. Around 1938, a few companies started to accept each other's cards, but it was quite limited.
Then came the invention of what we think of today as a “credit card” (versus a “store card” from Needless Markup, or a “gas card” from But Our Gas Has Platformate, or whatever.) One day in 1949, Mr. Frank McNamara, who was head of the Hamilton Credit Corporation, went out for dinner with Alfred Bloomingdale (yes, that Bloomingdale family) and Ralph Sneider, Frank's attorney. The three men were dining at Major's Cabin Grill, a then-famous New York restaurant.
The gentlemen began to discuss a problem Mr. McNamara was having with one of his customers who had borrowed money from Hamilton Credit. He was unable to pay it back because he had lent his department store and gas station charge cards to neighbors who needed items in an emergency. For this “service,” the gentleman in question required his neighbors to pay him back the cost of the original items plus a little extra vigorish for him. Unfortunately, (is this a familiar story?) his neighbors were unable to pay him back so he was forced to borrow more money from Hamilton Credit.
At the end of the meal, McNamara reached into his pocket for his wallet. He was chagrined to discover he had left his wallet at home. Embarrassed, he phoned his wife (did he have to borrow the dime from Bloomingdale? History is silent on this subject...) and have her bring him the cash.
Combining the two themes of the middleman role assumed by his customer in lending out his store and gas charge cards, and not having cash to pay for his meal, McNamara came up with a new idea - a credit card that could be used at multiple locations – not just Department Store #1 Card at Department Store #1, Gas Station #3 Card at Gas Station #3, etc. If that had kept on, pretty soon people would be carrying the plastic equivalent of a bucket of yak milk every time they went out.
Frank McNamara’s innovation was pretty simple, really: the credit card company he founded a few months later, Diners Club, became the middleman between companies and their customers, guaranteeing to both that obligations would be honored. McNamara gave 200 cards to friends and acquaintances and signed up 14 New York City restaurants. The cards were made of heavy paper stock with the names of the restaurants printed on the back. By the end of 1950, 20,000 people were using the Diners Club “credit” card at over 1000 restaurants. American Express then issued their first credit card in 1958, as did Bank of America (the BankAmericard -- now Visa.) And it was off to the races.
Now you can use a credit card to buy one item off the Dollar Menu at McDonald’s. And therein lies the problem. It isn’t like spending real cash. Many credit card users are shocked (shocked!) every month when they realize how much they have charged. Ultimately, they become indebted for their next 7 ponies and 12 buckets of yak milk. And if they dare miss a payment, Too Big To Fail Bank charges them 3 buckets of yak milk, their right arm, and their first-born child as a penalty.
One of the reasons I can’t get too excited about the prospects for our current rally to carry much above where it is today is that the “credit card” shoe has yet to drop. Subprime was the first blow, CDS’s another. Alt-A has yet to get its full licks in, and emerging market debt as well as commercial real estate refinancing (or not) are both lurking around the corner. But it’s credit card debt that could really deliver the knockout punch to any rally this year.
We need, as a nation, to work down the excessive levels of debt we are carrying. Americans are pretty smart, left to their own common sense – which is to say, in the absence of government jawboning that we take on more debt and banks trying to get us to use our credit cards more. That may help the government and the banks but it does zippo for you and me. And in fact, based upon the Fed’s most recent release (7 April) we are beginning to spend less and pay off our debts. According to the Fed, consumer credit decreased at an annual rate of 3-1/2 percent in February 2009. Regrettably, that still leaves $2 trillion, $564 billion in total consumer credit outstanding. (Which does not include home and investment mortgage debt, of course. We’re just talking about “stuff” in this category.)
That’s why I say credit cards have evolved “from dining convenience to eating our lunch.” I believe they will eat any further rally, as well...
DISCLOSURE: Long almost nothing. (A few high-yield bond funds, preferreds and convertibles.) Long lots of cash. Short via ETFs EUM, EEV, SKF, SRS, SH, REW, and SBB.