In the 17th Century swapping your perfectly functional home (the home which you need to live) for the bulb of a tulip became, momentarily, a decision that made you sit back in your seat and really contemplate. This is the bizarre scenario that occurred in the Netherlands, so bizarre in fact that is has rightfully earned the title ‘tulipmania’. Today the phrase ‘tulipmania’ is often used to refer to any significant increase speculative investment.
In this edition of The Tulip Teacher: the origin story of my name (nicknamed because of the oldest recorded economic bubble) and how ‘tulipmania’ came to be. Let’s take a look and it’s worth considering the strikingly similar traits it has with modern economic events.
As a precursor to understanding this horticultural madness, the Netherlands was the economic, scientific, artistic, and military force of Europe (possibly the world) at the time. This period is known as the Dutch Golden Age and as the title suggests, the Dutch people benefited in many ways but perhaps most importantly their household wealth grew – significantly. If there is anything that the wealthy love, it is showing it off and the acquisition of more wealth… the wealthy Dutch were no different.
Successful Dutch merchants were bringing their hauls of silver from captured ships, and Mexican and Peruvian mines and the Bank of Amsterdam (known for is fully backed deposits) was a perfect place to store their earnings. This meant more of the Dutch were walking around with a bit of change in their pockets and a new-found spring in their step. What better way to show that off than splashing out on the latest fashionable item of the time… rare tulips.
In 17th Century Netherlands tulips became an increasingly popular way to show off wealth, especially if they had a unique pattern that was caused by the ‘tulip breaking virus’ (that was worth paying a little extra for). Like any other sign of wealth, (cars, jets, watches, clothes) unique and limited items attract schmucks who are willing to pay more for them. This created the initial conditions for a bubble in the Dutch economy, but this alone cannot cause Tulipmania.
Professional and non-professional traders alike saw this increasing interest in tulips and the opportunity to make a bit of money if they could grow their own and sell them on. Traders began buying up as many bulbs as they could get their hands on in preparation for the growing season and paying good money for them. This reduced the number of bulbs available for any regular buyer looking to show off their wealth.
A reduced supply of already rare tulips meant significantly higher prices could be charged and believe or not, this attracted even higher demand. But this makes sense. These rare tulips are what is known as a Veblen good. Veblen goods work differently to ordinary goods like your bread, milk and cheese. Veblen goods are exclusive and a symbol of wealth. If the price increases the item becomes even more exclusive and therefore more appealing to those eager to be the king and queen of the castle. An infected tulip bulb in many ways was the Rolex of the 17th Century.
The high demand bubbling away in the Dutch economy led to the development of a ‘futures market’ in 1636. As the name implies you agree to pay for something that you will get in the future. In the tulip futures market contracts were created to between a buyer who wished to purchase the buds growing off the rare parent bulbs, and the seller who grew them. When the time was right the bulb is exchanged for the price agreed in the contract. This part is straight forward.
However, the tulip contracts could be traded. All it took was someone willing to pay an even higher price for it. Growing popularity and increasing prices for tulip bulbs meant there was an opportunity to make some money. All one had to do was simply buy the contract and sell it off to someone else for a higher price. Think of it as the riskiest version of the hot potato game you could ever play.
Throughout this period of mania, the serious and wealthy tulip fanciers who traded regularly in rare varieties did not participate in the new speculative markets. New participants in the market were mainly wealthy merchants and skilled craftsman. This suggests that information asymmetry could have contributed to the creation of the ‘Tulipmania’, through speculation by non-professionals in the tulip market.
Confidence and speculative buying in the tulip market grew so pervasive that even plain tulips with nothing special about them started to increase in value too. But what really makes an economic bubble, is the ‘pop’. At some point this confidence evaporated, the realisation of paying a vast amount of money for something with little intrinsic value kicks in. Pop. Imagine being one of those who were left holding a contract for a future tulip bulb that was now worth next to nothing.
It’s at this point you would think we learn our history lesson but economic bubbles (though less severe on average) have increased in frequency.
A single September Augustus bulb was sold for 5,500 guilders. At the time 5,5000 guilders exceeded 10 years worth of a skilled craftsman’s salary and was enough to comfortably purchase a house.[1]
References and Acknowledgments
[1] Nusteling, H. (1985) Welvaart en Werkgelegenheid in Amsterdam 1540–1860, pp. 114, 252, 254, 258.
Tulip Image, source: http://www.gazettenet.com/Will-we-heed-viral-lessons-from-broken-tulips-34038230
The Tulip Teacher 