Tulip Mania is known as a primary example of a bubble.
The Beginning of Tulip Mania
It all started in Holland, in the seventeenth century. Years before (in 1593), a botany professor from Vienna brought to Leyden, a city in the Dutch province of South Holland, some unusual plants from Turkey. The Dutch were fascinated with this new product, but were not very happy with its exorbitant price.
One night, a thief stole the bulbs from the professor’s house — the bulbs were then sold for a cheaper price but at greater profit (the professor’s costs were higher).
Over the next decade, the tulip became a popular but expensive item in Dutch gardens, but many of these bulbs were affected by a nonfatal virus called mosaic. The virus would change the appearance of the bulb, adding to it, contrasting colored stripes that looked like flames.
The Dutch adored these variations of bulbs which were called bizarres. The more bizarre the bulb, the higher its price. Soon after, tulipmania set in.
Bulb merchants tried to anticipate the next tulip “look” and would buy a large stockpile to anticipate an increase in price. The prices of the tulip-bulbs rose wildly.
The more expensive they became, the more people saw them as intelligent investments.
In Mackay’s book, Extraordinary Popular Delusions and the Madness of Crowds, we are told that the normal industries of Holland were forgotten about in favor of tulip-bulb speculation.
“Nobles, citizens, farmers, mechanics, seamen, footmen, maid-servants, even chimney sweeps and old clothes women dabbled in tulips.”
Everyone wanted in on the action. And each person who thought that they were too clever to enter into such a fool’s game, and who “knew” that the prices would not increase anymore, watched in disbelief as their friends and relatives got rich overnight. Few could resist the temptation.
In the final years of the tulip craze, which lasted around 3 years (1634 to 1637), people bartered their land, jewels, and furniture to buy more bulbs. Bulb prices reached astronomical levels.
As the proverb says, “Necessity is the mother of invention.”
People needed more ways to speculate, and like magic, the financial markets provided it. These instruments were known as “call options” which are now popular instruments in the stock market.
A call option conferred on the holder the right to buy tulip bulbs (call for their delivery) at a fixed price (usually approximating the current market price) during a specified period. He was charged an amount called the option premium, which might run 15 to 20 percent of the current market price. An option on a tulip bulb currently worth 100 guilders, for example, would cost the buyer only about 20 guilders. If the price moved up to 200 guilders, the option holder would exercise his right; he would buy at 100 and simultaneously sell at the then current price of 200. He then had a profit of 80 guilders (the 100 guilders appreciation less the 20 guilders he paid for the option).
A Random Walk Down Wallstreet, Burton Malkiel
In this way, a speculator could multiply his money by four. Options are one way to leverage your investment to higher the stakes (risk and reward). These devices opened up investment to more people.
Burton Malkiel recounts that this period of history was known for several tragicomic episodes. Another story was about a sailor who came back home, and told a wealthy merchant about a new shipment of goods. The merchant rewarded the sailor with a breakfast of fine red herring (fish).
The sailor saw what looked like an onion on the merchant’s counter. He used it as relish for his herring — little did he know that this “onion” was actually an expensive Semper Augustus tulip that could feed the crew of his ship for an entire year. He paid for his mistake. The merchant was imprisoned for several months on a felony charge.
The Tulip Mania Debate
If you look up The New Palgrave: A Dictionary of Economics, a discussion of the seventeenth century Dutch speculative mania will not be found. Guillermo Calvo made his contribution to Palgrave, and defines tulipmania as: “situations in which some prices behave in a way that appears not to be fully explainable by economic ‘fundamentals.’”
There was an academic debate about whether the Tulip-Mania craze was really an important economic event. Peter Garber, who is considered a Tulipmania expert, says that Tulipmania is not a mania at all, but can be explained by market fundamentals. Supply and demand factors are one explanation (the rise in prices was not merely due to speculation).
Rare bulbs (like Semper Augustus bulbs) were hard to reproduce and were in great demand. Rare bulbs would increase in price.
But this did not explain the increase in price of the common Witte Croonen bulb, that rose in price twenty-six times in January 1637, only to fall to one-twentieth of its peak price a week later. In more recent works, Garber admits that the increase and collapse of the relative price of these common bulbs is the remarkable feature of this phase of the speculation.”
As happens in all speculative crazes, prices eventually got so high that some people decided they would be prudent and sell their bulbs. Soon others followed suit. Like a snowball rolling downhill, bulb deflation grew at an increasingly rapid pace, and in no time at all panic reigned.
Even though government ministers stated that there was no reason for the prices of tulip bulbs to decrease, no one listened. Eventually, most bulbs became almost worthless, selling for no more than the price of a common onion.
Originally published at https://unearnedwisdom.com.