Generating Interest in Credit Cards

This article, published by the Ottawa citizen, is the closest to economic pseudo-science I’ve come across to date. Granted, other articles may exist, but I haven’t been looking too hard.

Now, I understand that most people don’t view economics as a science, and I won’t claim that it is in the sense that physics and chemistry are sciences, but there can be (and often is) a certain academic, if not scientific, rigor to how it is practiced. With this in mind, I turn to the opinions expressed in this article with a skeptical attitude.

An Imam in Ottawa has been advising his congregation against the use of credit cards due to Islamic rules that apparently prevent the use of any service that generates interest (the financial type). In itself, there’s nothing particularly wrong here. It’s only when the article goes on to suggest why interest is to be avoided, that the article strays into the realm of pseudo-economics.

Credit Cards
It’s the Americ– err, Canadian way. [Source]

They say:

Islam has always banned interest for the same reason usury is condemned in other faiths: it can sink debtors, even whole economies, as recent years have shown.

and

“Interest is demeaning to people,” added Ismail Barreh, an MBA student at the University of Ottawa who sat in on the conversation. “They are in need, and then you can take advantage of them.”

So what is interest? In most economic models, it’s recognized that for a number of reasons, people will save their money. This is the act of transferring income from now to some future date in order to allow for future consumption. This is usually done to allow for some type of stability of consumption in the face of unstable income. For example, a person might save money over the course of their working career so that when they retire they can continue to consume (i.e. buy stuff — food, housing, clothes, etc.) despite having no income.

It is also recognized that there’s a value to being able to spend money now as opposed to later. Interest, simply put, is the difference in value between money spent now, and the same money spent some time in the future. For example, if I were indifferent between two situations (that is to say that I would prefer either situation equally, were I presented with a choice between the two): having $100 to spend today and $110 to spend next year, my interest rate would be 10% ([$110-$100]/$100) per year. Now when it comes to the interest rates on bank loans and credit cards, interest rates are set by a slightly more complicated process, but the same basic principle holds. The interest rate is nothing more than a ratio of future consumption value to present consumption value. Or, more simply, it is the difference in value between the money you’re being lent to spend today, versus the value of the future money that you’ll have to pay back.

My Very Own Spock Five
Pictured: Future Money

Knowing what interest is, it’s hard to see how it can be viewed as inherently demeaning. It can certainly be argued that credit card interest rates are excessive, but this is not the same argument. The fact of the matter is that interest is a necessary part of banking and specifically saving, which is incredibly important to how modern finance works. All of those people who are putting money away in RRSPs, saving for their retirement, aren’t being demeaned — they’re planning for their future.

Is “interest” to blame for the sub-prime crisis and subsequent recession? To be honest, that’s a bit of a loaded question. The recession had a lot of causes, and most of them involved interest in one way or another, but only because it’s such a simple and fundamental principle of economics. Money and houses are also involved in most aspects of the sub-prime crisis, but that doesn’t make them inherently bad things, only that they’re ubiquitous in the mortgage market. Realistically, the sub-prime crisis was the result of a lot of bad policy, bad regulation, and unfortunate timing — a perfect economic storm, but certainly not the result of interest.

Of course, the Imam’s underlying message isn’t necessarily a bad one. Credit cards can be used responsibly, but they often aren’t. Credit card debt can be one of the hardest to recover from, due to overwhelmingly large interest rates and the fact that the companies allow people to take the “easy” way out by making minimum payments on balances. The result is that you can often pay more in interest to the credit card companies than you do towards the original purchase if you opt to pay only the minimum balance on your credit card. The truth is that the world would probably be a better place if people had a more thorough understanding of what credit cards are, and carefully weighed the risks of accumulating credit card debt.

The use of religious doctrine to get people to think again about using credit cards is an interesting, and not necessarily illegitimate, approach. I just wish this could happen without the intervening economics being butchered.

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  • Mitchell Gerskup

    Mitchell Gerskup recently graduated from the University of Toronto with a degree in Economics and Philosophy. An avid atheist and skeptic, he has served as the President of the University of Toronto Secular Alliance, helping to promote science, reason and critical thinking around Toronto. He also volunteers with the Centre for Inquiry’s Ontario branch, and currently sits on the CFI’s Committee for the Advancement of Scientific Skepticism. Mitchell is also an accomplished competitive debater, having debated all across Canada. In addition to issues of economics and philosophy, Mitchell is interested in the fields of science and technology.