You are at a bookstore and you take a look at this one book.
It costs 550 rupees.
Your very first thought would be, “Oh, that is expensive.”
This is called first order thinking. It means that our brain drives us to the most obvious conclusion.
But reading a book can help you
i. Learn how to communicate better.
ii. Impress your date.
iii. Increase your general awareness.
So, buying a book and reading it can turn out to be a great investment.
This approach is termed as second order thinking.
First order thinking in purchasing a credit card.
While purchasing a credit card, our brain almost follows a first order approach.
Buying a credit card can get one:
i. Free coupons.
ii. Discounts on certain products.
iii. Free food in airports and access to the lounge.
These services induce a dopamine kick in us and we begin to believe that maybe purchasing the credit card was not a bad idea after all.
Eventually we start treading the path from being simplistic to materialistic.
Our spending habits become unnecessarily high.
We start spending money on things we don’t really need just because we are getting a ‘discount’ on them through our credit card.
We spend money on items which are not appreciating assets (things which can help increase one’s cash flow). This eventually leads one into debt.
Credit cards promote bad debt.
In the US, 7/10 Americans have at least 1 credit card.
The US tries to promote something called consumeristic culture, where people thrive more and more in buying stuff.
According to a report in Mint,
55% of working Indians save towards retirement regularly. On the other hand, a 2019 CNBC survey states that only 10% of Americans are confident that they’ll have enough for retirement.
This happens because most Indians have grown in an environment where they have seen people save first, and spend later.
Now, ask yourself a question.
What are the items for which credit card companies usually give you a loan for?
Most probably you are taking a loan/paying EMI on durable liabilities.
When you buy a car or a phone, you’re not creating a source of income for yourself but rather cash outflow. This can eventually have grave consequences.
Now, a lot of people say that, “I am an effective credit card user. I pay my bills on time.”
Again, this article is not a criticism towards people who use credit cards judiciously.
But here is a more systemic question for you, so that you understand the business model of a credit card better-
Who pays for credit card conveniences?
There are credit card companies.
There are retailers (people who sell you stuff, e.g.- Apple store)
And then, there are people.
Credit card companies offer conveniences to people and retailers.
For retailers, credit card companies help them build marketing awareness.
For people, there is the comfort of not carrying cash, you can pay bills by just swiping your card, plus you get customer service as well.
Now, credit card companies make a LOT of money. But, how? Who is paying them?
It is either the people paying for these conveniences or retailers. Or both, retailers and people.
In economics terms, this is called the incidence of cost burden.
Let us take an example to understand this better.
When cigarette prices increase, who pays for the risen cost?
It is mostly people who smoke cigarettes. Sounds obvious, right?
This is because it is a habit oriented industry.
The retailers can pass on the entire cost burden to the customers, because cigarettes have inelastic demand (price increases, but quantity remains the same).
On the other hand let us take the example of an item which has flexible demand, like potatoes.
(flexible because people can simply use a different vegetable, if the price of potatoes skyrocket).
In this case, if the tax on potatoes increases, the retailers will absorb a certain amount of cost burden and then pass on the rest to the customer.
Similarly, the same issue holds for credit card companies.
It is the company that is making money, but who is substituting them/making them richer?
The people and retailers, because of the innumerable conveniences a credit card provides to them.
When we say conveniences, the idea to use a credit card can sound luring, right?
But here comes another question.
How amazing are credit cards REALLY?
You will have observed that a lot of YouTubers advocate the use of credit cards. A lot of blog articles on the internet also speak of them in a positive light.
You will not find a lot of content on the internet which will systematically criticise credit cards, as there is a high chance they will be taken down.
Also, quite often people forget that the credit card system varies across nations.
In the US, it is not very easy to haggle or bargain.
But the bargaining culture is very prevalent in India.
You don’t really need cashbacks or coupons.
Now a lot of people will make the argument that big supermarkets accept credit cards and give store discounts.
Would you rather buy cheaper vegetables from a regular vendor with no cashback or exorbitantly priced vegetables at supermarkets which are giving you cash backs?
So, it is important for you to do this simple analysis and use basic common sense, because at the end of the day
Simplicity is the best way to be financially free. 🙂