Douglas Mudd Plastic Cash: A History of Money and the Credit Card in America
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By Douglas Mudd

Abstract

Electronic media encompasses the relatively new areas of credit cards, smart cards and other forms of stored value or credit that are now becoming increasingly common. This type of monetary transaction and the technology with which it is associated has created a revolution in how people understand and use money. Credit is now available to the vast majority of Americans on a scale never before seen. Many important issues and problems remain to be resolved in this area of monetary usage, one of the most important of which is determining whom is to control the issuing of credit cards and regulate the amount and terms of the credit given to individuals.

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Electronic media encompasses the relatively new areas of credit cards, smart cards and other forms of stored value or credit that are now becoming increasingly common. This type of monetary transaction and the technology with which it is associated has created a revolution in how people understand and use money. Credit is now available to the vast majority of Americans on a scale never before seen. Many important issues and problems remain to be resolved in this area of monetary usage, one of the most important of which is determining whom is to control the issuing of credit cards and regulate the amount and terms of the credit given to individuals.

Currently, banks are the primary issuers of credit cards and are responsible for determining what amount of credit each cardholder has available (in essence they are 'creating' money), and whatever fees and/or interest rates are imposed, subject only to general regulations on credit and banking practices. Of the several types of cards available, credit cards are by far the most popular among Americans. The money of the future in the United States is increasingly identified with the credit card - an interesting development in our lifetimes that has important ramifications for the future. Americans are used to easily available credit - something that is not common in the rest of the world. Europeans use credit cards as well, but the card of choice is the stored value card that has a fixed amount of money associated with it - something that has not gone over particularly well with the American public either in the form of smart cards or debit cards.

Wild cards

Credit card debts on banks are not backed by a safety net of reserves or collateral in the way that other loans are, but are, in effect, based purely on consumer and corporate confidence in the credit cards themselves and the banks that issue them, in much the same way that modern US paper money is. The difference is that US paper money is backed by public confidence in the economic strength of the United States and the financial powers of the Federal government to control the supply of money and to tax the American people.

The important regulations put into place after the collapse of the American banking system in 1933 were created to protect the public from unscrupulous banking practices and to ensure that safeguards were in place to protect individual savings accounts from the total losses that occurred during the 1930s. These restrictions and safeguards have not been imposed onto the credit card industry, which has actually been able to roll back restrictions on the interest rates and on the limits to the legal amount of penalty fees over the last two decades. Thus, we have an industry creating money through the issuance of credit card accounts to as many people as possible - and preferably those people most likely to use the credit cards and pay only the minimum payments, thus maximising bank profits. The result has been a society increasingly in debt - the average American now has about $8,000 in credit card debt alone - to banks, without outside regulation, and without reference to the banks' ability to sustain the amount of their outstanding loans to credit card users. This is a recipe for disaster in the event of a serious banking crisis (as unimaginable as it may seem to some).

Early beginnings

Interestingly, the current situation in which banks and credit institutions are literally 'creating' money, largely independent of any Federal or other central authority regulating the amount of credit issued, has its parallels in early US history. During the period from 1795 until the creation of the National Bank system in the aftermath of the Civil War, the economy of the United States relied on paper money issued by State chartered banks and financial institutions. This situation was the result of several factors:

A) The United States had no significant domestic supplies of precious metals until the annexation of California and the discovery of gold there shortly afterwards

B) The American public's experience of paper money during the Revolution had so turned them against it that the Constitution expressly denied States the right to issue paper currency, and the Federal government itself became so reluctant to do so that, until the ultimate crisis of the Civil War, the Federal government would issue no regular paper money of its own (except in emergencies such as the War of 1812).

The problem was that the Federal government was simply not able to provide enough hard cash for the needs of the country and was unwilling to issue paper money as an alternative, so private banks and financial institutions stepped in and issued paper money under charters granted by the various State governments. Thus began the era of the 'Wildcat banks' or, for collectors of paper money, the obsolete banknote era (so-called because all of the banknotes issued in this period are now 'obsolete' - ie, they are no longer redeemable anywhere for their face value). During the first half of the 19th century, over 8,000 institutions issued paper money backed only by their reputations and the loose and variably enforced State regulations on banking.

The result was that, in effect, every town with a bank had its own paper money system. The money issued by each bank became increasingly worthless the further away from that bank, or a branch, you got. This was due to the inherent insecurity of the system - a merchant 40 miles away (ie, two days travel at the time) from the issuing bank had no way to be sure that, when he took the note he had received back to that bank to redeem it, the bank would still be there. If it was not, his note was now worthless. This situation was reflected in the newspapers of the time, which published lists of banknotes and their discounted rates in town - thus a banknote issued by a bank 40 miles away might be discounted 40% or 50% depending on the reputation and longevity of the issuer. Needless to say, if you had to travel any significant distance at the time, you carried hard cash in gold and silver.

Ups and downs

While the early growth of the United States would not have been possible without the obsolete banknotes, this system was also the source of instability and created a cycle of economic ups and downs that were devastating to individuals and the nation as a whole. The possibility for change came about with the discovery of gold in California and, soon after, silver in Nevada and Colorado. For the first time the United States had plentiful sources of gold and silver, allowing the government to finally issue enough coinage to meet domestic needs.

An important step was taken in 1857, when foreign coinage, used as legal tender since independence, was finally demonetised, making US coinage the only officially accepted money in this country for the first time. Unfortunately, the obsolete banknote system was so lucrative that it was easier to allow it to continue rather than to overhaul the legal codes in place at the State and Federal level and fight its powerful supporters. This state of affairs continued until the financial crisis brought on by the Civil War forced the Federal government to come up with a better solution in order to ensure the survival of the Union.

The Federal government issued its first regular series of paper money in 1861 in order to raise the necessary funds to fight the Civil War. These were the famous 'Greenbacks' and were followed by a number of different types of paper money in a continuous series up to the present day - all of the Federally issued paper money from 1861 is still considered legal tender and can still be used in payment of taxes at their printed face value. Of course, most of the older notes now have a collector value well in excess of their face value, so this principle is not much put to the test, but this was the basic way in which government paper money was backed - the government would use paper money to pay for goods and services and the recipient was guaranteed that they could use it to pay off their government debts.

By 1866 the Federal government created a new National Bank system under which all participant banks received national charters in return for making deposits at the Treasury in government bonds. The government insured the currency issued under the National Bank system, and Federal law strictly limited paper money issued by individual banks to a percentage of their reserves. For the first time, the United States had a stable paper money currency that would be accepted at face value wherever it was taken, no matter what bank issued it. This system was to remain in place until 1935, by which time the Federal Reserve System, under which our money is now regulated, was in place.

Birth of the credit card

Now back to the history of the credit card. Credit was first used in Assyria, Babylon and Egypt over 3,000 years ago. The bill of exchange - the forerunner of banknotes - was established in the 14th century.Debts were settled by one-third cash and two-thirds bill of exchange. Paper money followed only in the 17th century. By the 18th century a form of consumer credit was available through tallymen, who sold clothes in return for small weekly payments. They were called 'tallymen' because they kept a tally of what people had bought on a wooden stick. One side of the stick was marked with notches to represent the amount of debt and the other side was a record of payments. In the 1920s, the shopper's plate - a 'buy now, pay later' system - was introduced in the USA. It could only be used in the stores that issued it.

Diners Club of America issued the first credit cards in 1950 (invented by Diners Club founder Frank McNamara) usable only for payment of restaurant bills. These cards were unique in that they were not issued by retailers to extend credit to their customers, but by institutions uninvolved in retail as a service to buyers.

The success of the system was based on the number of retailers who would accept the cards, and its profits were based on the membership fees charged to borrowers and the processing fees charged to retailers. The first Diners Club card was issued to 200 customers who could use it at 27 restaurants in New York. Bank of America issued the BankAmericard (now Visa), the first bank credit card, in 1958. By the early 1960s, more companies offered credit cards, advertising them as a timesaving device rather than a form of credit. By the mid-'70s, Congress started to regulate the credit card industry by banning such practices as the mass mailing of active cards to people who had not requested them.

The first 'card' itself was actually a paper booklet (about the size of a modern plastic card) that listed all of the establishments that would accept the card. Eventually, these booklets were replaced by the plastic credit cards (in the early 1960s) once the list of places where each card would be accepted got to be too long - making the books too thick to be easily carried in a wallet. The invention of the magnetic strip in 1970 was a major milestone as it allowed credit cards to become part of the electronic information age. With the invention of the 'smart card', first for phone cards in the mid-1970s, a computer chip was added to credit cards, vastly expanding their possible uses.

Future cards

It will soon be possible to keep all of your personal information on an identification card that can act simultaneously as a credit card, medical history record, insurance card, driving licence, etc. The question is who will control all of this information? Will the Federal government, banks, or some other entity? On a more basic level, will people accept the loss of privacy required by such an all- inclusive system? With concerns over the security of digitised personal data and increasing instances of identity theft, there may be a retrenchment in public willingness to have all transactions, movements and personal information electronically recorded and monitored.

One thing is certain - that hard cash in the form of paper money or coinage will still be around for the foreseeable future, especially in societies where personal privacy is considered to be more important than economic convenience or efficiency.


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