Most adults today are aware of what a financial bubble is. They were either directly effected by or watched their parents deal with the dot com bubble and the great financial crisis happening in 2000 and 2008 respectively. An asset bubble is when the price of a particular asset rises so much that no longer reflects its inherent value.
Bubbles are normally noticed by a general sense of euphoria where almost everyone believes that the price will only continue going up. This phenomenon is called a bubble for a reason. Bubbles pop. This is where you hear about major market crashes and panics. It is when the bubble pops that it is said to crash.
One of the major asset bubbles in history is the Dutch Tulipomania that happened in Holland during the mid-1630s. As the story goes, the price of tulip bulbs rapidly increased to the point that people were paying more for a single tulip bulb then for a house. Some accounts state estimates of $150,000 to $750,000 for rare tulip bulbs.
Now, it is debated on how accurate those accounts are. Historian Anne Goldgar brings evidence that the story of the Tulip Mania is largely myth. However, I will give the accepted story of the mania first and then bring in her argument on whether the story is myth or not.
Background
Tulips arrived in Holland around 1593 when they were imported from the Tien Shan Mountain range in central Asia. They were viewed as an exotic item and became a status symbol and a showcase of wealth. There were no similar flowers in Holland at the time, so they were mostly planted in rich people’s gardens.
The main problem was that tulip bulbs are extremely fragile, so it took professional cultivators almost 40 years to be able to produce the bulbs locally. However, this business of cultivating tulips persists to this day in Holland.
In general, tulips are one solid color. However, it was the “broken bulbs” that were popular and drove the demand for the bulbs. The broken bulbs have striped or multicolored patterns due to a virus that severely weakens the flowers.
The Tulipomania
The broken bulbs were rare, and they were the ones to drive demand, as well as the price, higher. Eventually, middle class people started buying tulip bulbs for the simple reason that they were expensive. By 1634, when some accounts date as the advent of the tulip mania, even the lowest class of people started trading tulips. All for the hope to buy at a very high price, and then sell at an even higher price.
The Bubble Inflates
It shouldn’t come as a surprise that the participants started using leverage to buy more bulbs. They started using credit (borrowing of money) and growers started to sell their tulips through legal contracts similar to today’s futures contracts. The growers would sign contracts stating that they would sell their tulips at a predetermined price, and then that contract could be traded as well.
By the end of 1637, the price of tulips began to falter, and then began to plummet. By 1638, the Tulipomania was over, and the price of tulips had crashed.
The Pop
Since people had been buying tulips with credit and contracts, when the price began to falter, the people could not pay back the loans they took out to buy the tulips. This basically led to people having margin calls like today in the stock market. Meaning they had to sell all they could to pay back the loan.
When it came to the legal contracts with the growers, dealers started to refuse to honor the contracts when the price dropped, since the tulips were no longer worth the price that the contract stated. As you can imagine, this turned a lot of relationships sour and people lost a lot of trust.
It did not help that as the prices began to drop due to demand faltering, the production increased significantly of the tulips, aiding in the rapid decent of the price of the tulips. The bubble can be seen on the graph below. It says it is the tulip price index, so it is not the actual price of the tulips themselves. I believe it is the price of the tulips relative to their original price, so the number on the vertical axis might be a multiplier of the original price.
Fact or Fiction?
Scottish author Charles Mackey wrote a book called Extraordinary Popular Delusions and the Madness of crowds first published in 1841 about the Dutch Tulipomania. In the novel, he talks about how some of the bulbs easily sold for well over $100,000 in today’s dollars. This is one of the main sources of the story above as a lot of articles and posts about the tulipomania sourced their information from this book.
However, historian Anne Goldgar describes how Mackey’s novel is largely myth as the mania had no real effect on the economy of Holland at all. Goldgar received her information from the archives of Dutch cities and the manuscripts of public notaries and courts from the time.
According to Goldgar, the most expensive bulbs sold for about half of the price that other sources estimate. She also says that the trading remained with successful merchants and artisans and that other classes of people did not participate in the mania. Also, she could not find a single case of a person going bankrupt from the bubble bursting in 1638 according to an article posted on history.com2. All of this is contrary to what Charles Mackey wrote in his novel.
Goldgar stated that the reason for the exaggeration of the event by Mackey is he used satirical poetry as a source. He allegedly used it as if it were fact instead of the satire that it was. This leads one to believe that the mania was contained to a smaller group of wealthier than average individuals, and the original story was exaggerated.
Conclusions
The purpose of this post isn’t to tell the story of when a new flower got extremely expensive in Holland back in the seventeenth century. Asset bubbles and manias happen a lot. So, learning about them and their history is important for being financially educated so that you can make educated decisions with your hard-earned money.
One popular story from the event is a sailor mistook a tulip bulb as an onion and put the bulb on his sandwich and ate it. Allegedly, he this was a felony at the time, and he was thrown in prison for his very expensive sandwich.
Whether or not the Tulipomania story is accurate is irrelevant to the lessons it holds. People have shown a tendency to be irrational when it comes to asset prices. Being able to identify bubbles and their characteristics including the mood of the market is pivotal for a successful investor. It is definitely a skill that can make you fortunes if you know what you are doing, or it can at least prevent you from losing a lot of it.
To your wealth and future,
James Forsythe
For more important financial history try out
https://jamesdforsythe.com/category/important-history/
References
[1] https://www.investopedia.com/terms/d/dutch_tulip_bulb_market_bubble.asp
[2] https://www.history.com/news/tulip-mania-financial-crash-holland
[3] https://www.smithsonianmag.com/history/there-never-was-real-tulip-fever-180964915/
[4] https://corporatefinanceinstitute.com/resources/knowledge/economics/dutch-tulip-bulb-market-bubble/
