Photo courtesy C.Valdez on Unsplash.
In the year 2021, we have seen the price of a single Bitcoin skyrocket to $68,000 for a brief period while it was just $1 in 2012. In the same way, we have seen the price of certain asset classes rise quickly in the past. The price rise is too quick and fails to justify the inherent fundamentals, so there is a crash in the asset price due to the bubble. The Tulip mania of the 1630s is often considered the first recorded economic bubble in history and there is a lesson in it for the stock and crypto investors.
There was a similar dot-com bubble in the late 1990s that saw the rapid rise in the US technology stocks due to investments in internet-based companies. The bubble burst between 2001 and 2002 and the equity markets entered a bear phase. We will now discuss the Tulip mania.
In the mid-1600s, the Dutch economy grew, and there were abundant wealth and prosperity. The nation found independence from Spain and the Dutch merchants grew very rich due to the trade. With plenty of money to spend, art and exotica became a matter of interest among collectors and this was how the Dutch became fascinated with the rare Tulips resulting in the start of Tulipmania.
The first Tulip seeds and bulbs were first sent to Vienna in 1554, from the Ottoman Empire. These bulbs were soon distributed from Vienna to Amsterdam. The popularity of these flowers grew when a botanist named Carolus Clusius after planting found that they could tolerate the harsher climate in Southern Netherlands.
Due to the newfound prosperity, the Amsterdam merchants were involved in lucrative East Indies trade where one voyage could result in a profit of up to 400%. Money was plenty and tulips became a desired luxury item and many varieties were introduced.
The various classifications of the flower groups were: single-colored tulips of red, white, or yellow; multicolored with white streaks on a red or pink flower, white streak on a purple background, and the very rare yellow or white streak on red, brown, or purple flowers. The multicolor streaks made the flower appear even more exotic and beautiful, but now it is well known that the streaks are due to the effect of a mosaic virus that breaks the petal color into two or more colors.
In the mania, growers gave the flowers many prestigious names like admiral, general, admiral of admirals, or even the general of generals according to the quality. Most of those varieties are not available now. Tulips can be grown either from the seeds or the buds. Seeds from Tulip form buds after 7–12 years and when the bulb becomes a flower the original bulb disappears but several bulbs appear in its place.
The Tulip blooms around April and May and during the plants dormant phase from June to September, the bulbs can be uprooted and moved around, so actual purchase happened during these months. The rest of the year the traders signed contracts in front of a notary at the end of the season (Futures contract).
The popularity of the flowers was increasing by the day and people were willing to pay more and more prices especially for the bulb with the virus. Soon, the French speculators too started entering the market. The contract price of the rare bulb was rising throughout 1636, but by November the price of the common bulbs too started to go North.
The Dutch created a Futures Market in that year. The traders used to meet in taverns and a wine fee of 2.5% was introduced per trade. There was no mark-to-market system. This was just the Futures trade and no bulbs were actually changing hands.
The tulip bulb had become the fourth leading export in the Netherlands after gin, herrings, and cheese. Due to the speculation involved the price of tulips began to skyrocket. Many people made and lost fortune overnight.
If we consider the stock prices in the share market it all depends on demand and supply. When speculators and investors expect an increase in earnings the share price rises. Similarly here the demand for tulips was higher than supply and the price was expected to rise in the future.
The tulip mania reached its peak in 1636–37 and many bulb contracts changed hands ten times a day. There were no deliveries made to fulfill the contracts because the bulb prices began to collapse by the February of 1637. The collapse began in Haarlem where the bubonic plague had broken out and people did not attend the auction. The outbreak of the plague may have helped to burst the bubble.
In 1841, Scottish journalist Charles Mackay published a book “Extraordinary Popular Delusions and the Madness of Crowds” and in this, he mentioned that at one point 12 acres of land were offered for a tulip Semper Augustus bulb. He further claimed in his book that many investors were ruined by the sudden fall in prices and Dutch commerce suffered a serious setback.
According to Mackay, the popularity of tulips caught the attention of the entire nation. Many people became rich suddenly and it is now known that the tulips were traded on the exchanges of many towns and cities by 1636. People rushed to the tulip markets like flies around a honey pot. Every class of society dabbled in tulips. Everyone thought that this fervor would last forever and the wealthy from all parts of the world would pay whatever price they were asked for.
A sale of 40 bulbs for 1,00,000 florins (Dutch guilders) was recorded in 1635. If we compare this to other items; a ton of butter costs around 100 florins, eight fat swine around 240 florins, a skilled laborer earned around 150–350 florins a year. At the height of the bubble, the tulips were so costly, roughly equal to10,000 guilders, which were a huge price and equal to the value of a mansion on the Amsterdam Grand Canal.
People were buying bulbs at high prices with the idea of selling them at a still higher profit. This could not last forever unless someone was willing to pay such high prices, and in February 1637 no new buyers could be found who would pay such inflated prices for the bulbs. When the realization set in, the prices collapsed, and the bubble burst. Many people were left holding the bulbs at a fraction of the price they had purchased.
The panicked speculators sought the help of the government of the Netherlands which declared that anyone who had bought Future contracts could void their contract by payment of a 10 percent fee. No court could enforce payment of a contract as the judges regarded debts as contracted through gambling and therefore not enforceable by law.
Since the 1980s economists have raised doubts over many aspects of Mackay’s accounts. In her article in 2007, Tulipmania, Anne Goldgar has stated that the phenomenon was limited to a small group of people and most of the accounts from this period are based on one or two pieces of propaganda. Goldgar’s study of archived accounts found that the trade-in tulip contracts were carried out exclusively by merchants, so the economic fallout from the bubble would have been limited.
Goldgar argues that the speculative bubble may have been traumatic to the Dutch people for other reasons. The valuation of assets was thrown into doubt as they observed that a flower could cost much more than what most people earned in a year.
Earl Thomson an economist has noted that because of the production lag and the fact that growers entered into legal contacts to sell their tulips at a later date, prices rose due to the simple fact that suppliers could not satisfy all the demand. The rise in price occurred so rapidly after the bulbs were planted for the year that the growers did not have the opportunity to raise production in relation to price. Actual sales of tulip bulbs remained at ordinary levels right through the period.
It is agreed by everyone that a few people paid a very heavy price and lost a lot of money. The story revolves around modern public talk as a moral lesson that greed is bad and chasing fast-rising prices can be dangerous. It has become a tale about markets and morality and used to remind us that what goes up must come down. The lessons learned from tulip mania are –
- At times the markets can be irrational. The herd mentality of investors and traders is partly responsible for this.
- There is the greater fool theory. People think that they would be able to sell at a higher price. When the price becomes unaffordable the buyers would not be there and the prices would come down or crash.
- An asset can become inflated in price due to irrationality. But in due course its price will correct to its true value.
- It is next to impossible to time the markets and predict the top and bottoms of bull or bear market.