The Tulip Mania

The Dutch were the first in doing something in many life aspects and surely they were among the first to create a financial bubble which burst in February 1637, it is considered the first recorded speculative bubble.

The tulip, a flower introduced in Europe about one century before, was different than any other flower at that time. These flowers are characterised by intense saturated petal colours caused by the mosaic virus and soon became a status symbol of that era. The Netherlands started massime production of tulips relying on its fast growing trade network for the flower sales, the period is also referred as the Dutch golden age.

Tulips grow from bulbs, and can be propagated through both seeds and buds but it takes several years for the seeds to create a bulb. When a bulb grows into the flower, the original bulb will disappear, but a clone bulb forms in its place, as do several buds. Once cultivated, these buds will become bulbs of their own. The important fact is that the mosaic virus which, as said, is responsible for the saturated colours, only propagates via the buds. The cultivation of tulips as well as the generation of new varieties take therefore several years, a pretty long process.

The price of the tulips started growing rapidly due to the uniqueness of these flowers.The only moment the bulbs can be uprooted and physically sold is during the dormant phase that goes from June to September. During the rest of the year tulip traders were going to notaries to sign contracts to buy bulbs in the next dormant season, creating one of the first if not the first futures contracts. As we know Dutch people are skilled when it goes to finance and a market for tulip bulbs was effectively created.

Bulb prices kept growing and speculators came in the picture buying and reselling bulbs contract without ever seeing a physical bulb. In 1636 an official Exchange market was created to trade bulb features contracts. These trades were apparently pretty much fun since they were done in taverns with people drinking (being in a bubble it is always fun... till the bubble bursts).

Some bulbs were sold at a price equivalent to 10 times the yearly salary of a highly paid worker. Some people became suddenly very rich and more and more people started trading tulip features selling or trading their houses and goods in order to finance their tulip features purchase.

During the winter of 1936-37 bulb features contracts were traded up to 10 times a day but for none of these contracts any real bulb was ever delivered. In February 1937 the bulb features contracts market suddenly collapsed. The price drop started in Haarlem where traders refused to participate to the regular features auction. In less than 30 days some of the features contracts lost up to 99% of their pick value. The world first recorded speculative bubble had finally burst and many people lost suddenly their wealth.

What can we learn from this story? The first and most important lesson is that every speculative bubble eventually burst. You can make huge money during the period where the bubble is inflated but you can lose them all when it burst if you are still in the bubble.

A second lesson is to be able to distinguish between the real value of an object (also called the intrinsic value) and the speculative value that an object can have in a particular moment of time. A tulip bulb, especially of the most rare types, surely had a real value due to its uniqueness and its scarcity (remember it takes several years to create a bulb) but is it reasonable that a bulb (a flower!) could be worth 10 times the yearly salary of a skilled worker? Obviously not and that was a clear indication that the market value was way above the intrinsic value, hence a speculative bubble was being inflated.

Every time the market value of an object, which in principle should only be determined by the supply and demand process, is significantly above its intrinsic value there is a bubble being inflated.

In a normal market condition a person would have bought a bulb features contract to then wait for the dormant season to receive the bulb and sell the resulting flowers making a profit. This is the way sound capitalism work. When speculators came in to buy and resell the features contract with absolutely no intentions to ever get the physical bulbs or sell the flowers they started inflating the bubble. Their profit was coming from a supposed ever growing features price rather than from the profit of the real actions of planting and selling flowers. This is not capitalism, this is called crony capitalism. Their action made the flowers price artificially growing but question yourself: who would ever buy flowers at so high price with his/her own money? The bubble was clearly set to burst.

Though the event is in the distant past so it is not easy to trace back all data but there is evidence that before 1937 there was an increase in money supply by the government (what today we would call printing money). This increase in money supply helped the speculators to finance the inflation of the bubble. Another important learned lesson: an increase of money supply is always extremely likely to inflate a speculative bubble. Politicians love to increase the money supply, especially these days, cause they can give these supposed to be free money to the people in order to keep their seats and the negative effect often comes only a few years later. Always be careful when you see an increase in money supply. This will be the main subject of another post, so stay tuned.

From this story we can get quite some hints on how to recognise an inflating speculative bubble but what was the pin that pricked the bubble? Again being a distant past not all data is certain and it could be that the bubble burst by itself simply cause it was too inflated. On the other side in Haarlem in the winter of 1936-37 there was an outbreak of the bubonic plague. A pandemic disease is always an event that make people lose confidence in their future, people move quickly to a defensive attitude (often simply driven by panic) and are less willing to make investments with their money cause they know they need these money for survival reasons. The bulb features prices was growing only for the reason that people were confident that somebody else was later so fool to buy the features contract at a higher price. Lost this confidence the features market was basically over.

The outbreak of the bubonic plague was likely the pin that pricked that bubble. The bubonic plague was not the problem that created that financial crises, the speculators behaviour that inflated the bubble was the problem. The bubonic plague just pricked the bubble, if there wasn't any outbreak of the plague the bubble would have eventually burst anyway by itself or when it would have encountered another pin.

If you have to remember only one thing about this story make sure it is that EVERY BUBBLE EVENTUALLY BURST.

#financial #crises #tulipmania #tulip