Is The Abuse Of Points Credit Cards Bad For The Economy?

"Can some please guide on how to churn credit cards, for example if I have applied for certain cards, like Chase Sapphire, Bold etc or other brand cards, can I cancel them and re open after 2 years. How does it all work when it comes to get the bonuses again? Thanks" - ftuser1, Flyertalk

August 2013 marks my second year using the Starwood Preferred Guest Credit Card from American Express , and I have to give it a glowing recommendation. The points that I earn are transferable to dozens of different programs, the customer service is great and the American Express brand is outstanding for consumer protection. Ironically, I rarely use the card to book rooms or redeem points at Starwood hotel properties. In fact, I usually don't stay in hotels - I'd rather stay with friends or family - yet, I still own the card.  The reason: the perks have proven to be too enticing.

The loyalty points industry is surging thanks to a new crop of frugal travelers and some savvy marketing groups within the credit card industry. It used to be that points could only be earned by flying on an airline or staying at a hotel, but those loyalty programs have been expanding into commercial portals and incentive programs. Need to buy flowers for Mother's Day? There's an FTD incentive that will get you extra points for that. How about a new checking account? Citibank has a bonus that should help entice you.

But the real cash cow for those looking to maximize miles has always been the rewards credit card. Introduction of the rewards card allowed for consumers to earn loyalty points instead of cash back on everyday purchases, and aggressive signup incentives are raking in new users in droves. A recent promotion from British Airways promised 100,000 miles after signing up for their Visa card, enough for two round trip tickets across the Atlantic (plus taxes). New cards and promotions are fastidiously monitored at sites like Flyertalk and Milepoint, and when a good deal hits the market, the community pounces.

Depending on one's travel habits, the points earned by signup incentives and annual spend can be quite lucrative. Some points have become so valuable that consumers are manufacturing artificial spend on their cards to earn the highest volume of rewards each month. For example, a common technique is to buy gift cards from the local store shelves and use that balance to circuitously pay off the credit card balance. Another now defunct program from the US mint designed to put dollar coins into circulation (with no shipping costs) had some hauling hand trucks of coins into their local banks just to earn rewards points.

The end result is a ghost economy of high-spend consumers fed continuously by credit card companies that are waiting to pounce on fees. And the financial impact of that churn can be perverse.

On a personal level, applying for and excessive spending on credit cards can adversely affect one's credit rating. Each credit card application records an inquiry on one's credit rating, and multiple inquiries per year can drop one's score. Additionally, having multiple recent cards (many in the community have over a dozen) will also affect the average age of one's credit history; a younger average credit age can result in a lower credit score.

Lower credit scores can lead to a higher interest rate when consumers are looking for a loan. John Ulzheimer, President of Consumer Education of SmartCredit.com warns against opening too many new accounts in a short period of time, especially prior to making big financial moves. "The trade off is simply not there when you consider the added cost of credit compared to the value of additional credit card rewards.  You'll pay more in the long run by chasing reward points."

Though they're difficult to measure, there can also be effects on the macroeconmic scale. Fumiko Hayashi, Senior Economist at the Federal Reserve Bank of Kansas City, asserts that the bulk higher volume of credit card transactions "increases the costs of processing payments through inflating spending (and thus transactions)." So while the lay consumer can buy a gift card for $500 and use that full balance to pay off his rewards card, each swipe uses resources, such as labor and capital. And when those resources aggregate, the national cost of processing payments goes up.

Still, the number of credit card transactions incurred from churning mileage cards is minuscule compared to the national volume of transactions each day. "Given all the potential costs associated with it for consumers, I predict that the number of consumers who will engage in this type of behavior would be very small" Ms. Hayashi suggested, "as a result, its negative impact on macroeconomics would also be very small."

It seems then that there's little reason to discourage churning miles cards and manufacturing artificial spend to reap higher rewards. The few that properly work the system to avoid paying fees while earning thousands of miles are offset by the many who pay late payments and high interest rates, so the banks are happy to provide the cards. "Credit card issuers are already adding the cost of churning in their fees and rates," Mr. Ulzheimer concluded.

In the end, the real winners in the mileage churning game seem to be those that carefully monitor the incentives, keep close track of their credit score and make all of their payments on time. It's a time consuming and articulate process, and those who fail at the game risk the high price of late fees and extra interest. But for those who succeed, the sky is the limit.