- Published: Thursday, 28 August 2014 10:32
- Written by Lucian Dronca
The jargon of economics and finance contains numerous colourful expressions to denote a market-determined asset price at odds with any reasonable economic explanation. Such words as "tulip mania," "bubble," "chain letter," "Ponzi scheme," "panic," "crash," and "financial crisis" immediately evoke images of frenzied and probably irrational speculative activity. Many of these terms have emerged from specific speculative episodes which have been sufficiently frequent and important that they underpin a strong current belief among economists that key capital markets sometimes generate irrational and inefficient pricing.
“Tulipmania”, the speculative craze for tulip bulbs in the Netherlands of the 1630’s, has long been a source of wonder for historians and laymen alike. Stories have been circulating for nearly 400 years about the apparently strange compulsion that led otherwise sensible merchants, nobles and artisan weavers to spend all they had and more on tulips, only to land in bankruptcy and ruin in February 1637.
An understanding of the tulip markets requires some information about the nature of the tulip. To present-day investors, the tulip is nothing more, nothing less, than a lovely garden flower. It grows from a bulb. It has leaves. And it has a stem - from 4 inches to more than 30 inches tall - on the tip of which, one large, bell-shaped flower usually develops. A bulb flower, the tulip can propagate either through seeds or through buds that form on the mother bulb.
Properly cultivated, the buds can directly reproduce another bulb. Each bulb, after planting, eventually disappears during the growing season. By the end of the season, the original bulb is replaced by a clone, the primary bud that is now a functioning bulb, and by a few secondary buds. Asexual reproduction through buds, the principal propagation method, produces an increase in bulbs at a maximum annual rate of from 100 percent to 150 percent in normal bulbs.
A bulb produced directly from seed requires 7-12 years before it flowers. The flowers appear in April or May and last for about a week. The amount of time required before the secondary buds flower depends on the size of the bulb produced from the bud. In June, bulbs can be removed from their beds but must be replanted by September. To verify the delivery of a specific variety, spot trading in bulbs had to occur immediately after the flowering period, usually in June.
The tulip market involved only bulbs affected by a mosaic virus which had the effect of creating beautiful, feathered patterns in the flowers. (If the flower is streaked with colors, the cause is that viral disease that affects the plant's color but not its health.) Only diseased bulbs were valued by traders and collectors, because a particular pattern could not be reproduced through seed propagation.
Thousands of varieties of tulips have developed from a few species. Almost all the cultivated kinds of tulips were developed from tulips of Asia Minor that were brought to Vienna from Constantinople (now Istanbul) in the 1500s. The name "tulip" comes from a Turkish word meaning turban, which was given to the flower because the beautiful blossoms look like turbans. Popular garden varieties of tulips include the Darwin hybrids and the Triumphs, Lily-Flowered, Fringed, and Parrot tulips.
Tulips belong to the lily family, Liliaceae. The tulip brought to Europe in the 1500s is Tulipa gesneriana. Although tulips grow in many parts of the world, they are generally associated with the Netherlands, where tulips cultivation has remained an important industry from the time of their introduction into Europe to today. Tulips cultivation is also important in the northwestern part of the United States. Billions of tulip bulbs are produced every year.
After the tulip was brought to Europe, it became the most fashionable flower in England and Holland. Interest in the flower developed into a craze in Holland between 1634 and 1637 that is referred to as "tulipmania." Individual bulbs sold for huge prices. Although many of today's investors are vaguely familiar with this tulip mania, most do not realize just how high tulip prices reached in this period or how destructive the mania became.
A fascinating early account of Holland's tulip mania can be found in Mackay's (1841) classic Memoirs of Extraordinary Popular Delusions and the Madness of Crowds. Mackay related details of tulip mania, the Mississippi Scheme, the South Sea Bubble, witch hunts, slow poisoners, and other similar phenomena. His objective was to recount remarkable instances of “moral epidemics which have been excited, sometimes by one cause and sometimes by another, and to show how easily the masses have been led astray, and how imitative and gregarious men are, even in their infatuations and crimes.” (p. XVII). Mackay's underlying assumption is clearly that aberrant crowd behaviour in the world of investing bears resemblance to aberrant crowd behaviour in the wild world.
In the 1600s, the Netherlands was a major sea power that accounted for roughly half of Europe's shipping trade. In 1602, Dutch firms trading with the East Indies combined to form the Dutch East India Company. Another company, the Dutch West India Company, founded in 1621, had opened trade with the New World and western Africa. In 1624, the Dutch West India Company colonized New Netherland, which consisted of parts of present-day New York, New Jersey, Connecticut, and Delaware.
In 1626, Dutch colonists bought Manhattan Island from the Native Americans for goods worth about $24. They had established New Amsterdam (now New York City) the year before. Expanding trade and the international influence of a great colonial empire made Amsterdam a major commercial city, and gave the Dutch one of the highest standards of living in the world.
It was during this "golden age" that tulips were introduced to the Netherlands. Conrad Gesner is credited with bringing the first tulip bulbs from Constantinople in 1559 to Holland and Germany, where they became much sought after among the rich and well-to-do. By 1634, the rage for possessing tulips had spread to the middle classes of Dutch society. Merchants and shopkeepers began to vie with one another in the preposterous prices being charged for simple tulip bulbs.
The tulip was immediately accepted by the wealthy as a beautiful and rare flower, appropriate for the most stylish gardens. The market was for durable bulbs, not flowers. As in so many other markets, the Dutch dominated that for tulips, initiating the development of methods to create new flower varieties.
The market for bulbs was limited to professional growers until 1634, but participation encompassed a more general class of speculators by the end of the same year. A rising demand for bulbs in France apparently drove the speculation. Market participants could make many types of deals. The rare flowers were called "piece" goods, and particular bulbs were sold by their weight. The heavier bulbs had more outgrowths and therefore represented a collection of future bulbs. Once markets developed in common bulbs, they were sold in standardized units of 1,000 azen or 1 pound.
A purchase between September and June was necessarily a contract for future delivery. Also, markets materialized for the outgrowths of the rarer bulbs. The outgrowths could not be delivered immediately since they had to attain some minimum size before they could be separated from the parent bulb to assure the viability of the new bulb. Hence, the contracts for outgrowths were also for future delivery.
Typically, the buyer did not currently possess the cash to be delivered on the settlement date and the seller did not currently possess the bulb. Neither party intended a delivery on the settlement date; only a payment of the difference between the contract and settlement price was expected. Thus, as a bet on the price of the bulbs on the settlement date, this market was not different in function from currently operating futures markets. The operational differences were that the contracts were not continuously marked to market, required no margin deposits to guarantee compliance, and consisted of commitments of individuals rather than an exchange. No bulbs were delivered under the deals struck in the new futures markets in 1636-37 prior to the collapse because of the necessity of waiting until June to exhume the bulbs.
According to Mackay, by 1636, regular marts for the sale of tulip bulbs had been established on the Amsterdam Stock Exchange and in Rotterdam, Haarlem, Leyden, Hoorn, and other towns. Popular interest in tulips had shifted from hobbyists and collectors to stock jobbers, speculators, and gamblers. As a nonessential agricultural commodity, the tulip could be reproduced rapidly and without limit, should its relative price have increased. Professional growers and wealthy flower fanciers created a market for rare varieties in which bulbs sold at high prices. For example, a Semper Augustus bulb sold for 2000 guilders in 1625, an amount of gold worth today about $16,000 at $400 per ounce.
Men were known to have paid a fortune for a single bulb - not with the idea of reselling at a profit but simply for private admiration. Later, investors began to accumulate tulip bulbs for resale and trading. Beginning in 1634, non-professionals entered the tulip trade in large numbers. Earlier deals had employed written contracts entered into before a notary. Trading became extensive enough in the summer of 1636 when traders began meeting in numerous taverns in groups called "colleges," where trades were regulated by a few rules governing the method of bidding and fees.
Each sale was associated with a payment of "wine money." In January 1637, prices for some common bulb varieties increased by as much as 25 times. No margin was required from either party, so bankruptcy constraints did not restrict the magnitude of an individual's position.
Mackay cites the prices of tulip bulbs in florins. For example, he notes that fortunes of as much as 100,000 florins went to the purchase of as few as 40 tulip bulbs. Various tulip bulbs were fetching 1,260- 5,500 florins each at the height of tulip mania in 1635.
(The florin was a coin that originated in the Italian city of Florence in 1252. Made of pure gold, the original florin weighed about an eighth of an ounce (3.5 grams). Florins became popular for trade during the economic expansion of Europe from the 1200s to the 1400s. Ironically, the coin's name comes from an Italian word meaning little flower. It refers to a lily, the symbol of Florence, which appears on one side of the coin. Florence stopped making florins in the early 1500s, but many European countries, including the Netherlands, produced their own versions of the florin.)
In those times for somebody to take a long lasting position in tulip bulbs market required substantial capital resources or access to the financial credit markets. To hedge this position with a short sale in the futures market would have required the future purchaser to have substantial capital or access to sound credit; substantial risk of noncompliance with the deal in the futures market would have undermined the hedge.
Since participants in the futures markets faced no capital requirements, there was no basis for an arbitrage. During most of the period of the tulip speculation, high prices and recorded trading occurred only for the rare bulbs. Common bulbs did not figure in the speculation until November 1636.
Strangely enough, if one is to speak of tulip mania, it would be more accurate to speak of the rapid price rise and collapse in common bulbs in the last week of January and first week of February 1637. Members of the middle classes and capitalized workers such as the weavers disdained the pound goods and traded only in the rarer bulbs.
The bulbs that can be included among piece goods are Semper Augustus, Admirael Liefkens, Admirael van der Eyck, and Gouda. Among these, the Gouda can be considered a standard since we have the most detailed price series for this bulb, starting at the beginning of the speculation. The pound goods sold at much lower prices per pound than the piece goods. In the last month of the speculation, however, their prices increased much more rapidly than those of the piece goods, rising up to twentyfold. Over a much longer period, the prices of the piece goods only doubled or perhaps tripled.
People from all walks of life liquidated homes and real estate at ridiculously low prices to gamer funds for tulip speculation. Tulip notaries and clerks were appointed to record transactions; intricate public laws and regulations were developed to control the tulip trade.
Prices of individual bulbs reached enormous levels; for example, a single Semper Augustus bulb was sold at the height of the speculation for 5,500 guilders, a weight of gold equal to $50,000. The lunacy of the event is emphasized through a pair of anecdotes about a sailor's mistakenly eating valuable bulbs believing he eats onions and an unsuspecting English traveler experimenting with them by peeling off their layers.
Large amounts of foreign funds entered in Holland to add to the speculation and people from all classes hurriedly liquidated other assets to participate in the tulip market. By 1636, the rapid price raises attracted speculators, and prices of many varieties surged upward from November 1636 through January 1637.
Then, in the early autumn of 1636, some prudent investors began to liquidate their tulip holdings. Tulip prices began to weaken, slowly at first and then more rapidly. In February 1637, prices suddenly collapsed, and bulbs could not be sold at 10 percent of their peak values. Soon, confidence was destroyed and panic seized the market. Within six weeks, tulip prices had crashed by 90 percent or more. Defaults on purchase contracts were widespread.
Finally and inexplicably, the frenzy terminated and, overnight, even rare bulbs could find no buyers at 10 percent of their previous prices, creating a long-term economic distress in Holland. A general suspension of settlement occurred on contracts coming due. On April 27, 1637, the states of Holland decided to suspend all contracts, giving the seller the right to sell contracted bulbs at market prices during the suspension.
The Provincial Council in The Hague was asked to invent some measure to stabilize tulip prices and public credit. All efforts failed. Tulip prices fell even lower. In Amsterdam, judges unanimously refused to honour tulip contracts on the grounds that gambling debts were not debts in the eyes of the law. No court in Holland would enforce payment.
Dutch tulip collectors, stock jobbers, speculators, and gamblers who held tulips at the time of the collapse were left to bear ruinous losses. Tulip prices soon plunged to less than the present equivalent of a dollar (or 10 guineas) each. Those lucky enough to have profited were allowed to keep their gains. Many of those who profited from the mania and the ensuing collapse apparently converted their gains into English or other funds to hide them from their enraged countrymen.
That price of "intrinsically useless" bulbs could rise so high and collapse so rapidly provide a decisive example of the instability and irrationality that may materialize in asset markets. The Dutch tulip mania of 1634-37 always appears as a favourite case of speculative excess, even providing a synonym in our jargon for a speculative mania. The Mississippi and South Sea bubbles are the other two examples that appear on everyone's short list; these provide yet another synonym for speculative mania.
The tulip mania made its first appearance in serious economics journals with the development of capital theory in the 1950s and the discovery of the potential existence of multiple, dynamically unstable asset price paths. In the finance literature, the emergence of empirical anomalies has also generated references to tulip mania as bubble.
All discussions of the tulip mania openly criticize the activity of buying or selling for future delivery without current possession of the commodity sold or an intention to effect delivery.
However, some analysts consider tulip contract prices before, during, and after the “tulipmania” as to provide a remarkable illustration of efficient market prices, where options prices approximated the expected costs to the informed suppliers.
More recent theories suggest that the social consequences of the tulip mania were actually not at all appalling, as they have been described afterward in different moralizing stories. The number of people involved in the speculation was relatively low (craftsmen, contractors, artisans, wealthy merchants) and the speculation did not encompass large social categories.
Historians also could not find a “prolonged depression” after tulipmania. Most historians agree that the Dutch economy continued to grow until the mid-seventeenth century in nearly every area: industry, overseas trade, living standards of the population. If tulipmania affected this situation at all, it would only have been in a minor way.
This is much less surprising when we consider the relatively small group of those involved in tulip trading, the majority of them being wealthy merchants who could afford to take the loss. The kind of people who spent large sums on tulips was not, for the most part, at the lower end of society. So what we get from most modern discussions of the tulip trade is, in fact, a specific seventeenth-century view – and a moralizing one – of the dangers of luxury in the wrong hands and consisting of the wrong things.
But, one might argue, it was ridiculous to spend so much money on tulip bulbs at all. This argument, like many others made about tulipmania, comes to us directly from the songs and broadsides of 1637, which made moral judgements about what was a suitable way to spend one’s money. The only insanity we can cite in tulipmania is a failure to foresee a crash: for in a rising market it is not insane to buy something that one can resell at a higher price.
Some of the merchants who bought tulips were, in any case, interested in the aesthetic side of the flowers, in the pleasure and sociability of collecting them and the culture they entailed. We can identify a crossover of aesthetic and commercial interests that had infused the fascination with tulips since their introduction to Europe in the sixteenth century. Those involved in the tulipmania brought together an interest in rarities as well as in profit.
The level of 18th century prices for tulips was much lower than during the mania. By 1707, an enormous variety of tulip bulbs had been developed; and the tulip itself had been replaced as the most fashionable flower by hyacinth.
All subsequent stock jobber attempts to recreate tulip mania in Holland, England, and France proved fruitless. Although tulips are still more popular in Holland than elsewhere, tulip prices there have never again approached levels seen in 1634 through 1636. Today, serious horticulturists can buy rare "collections" of Emperor Tulips, Mid-Season tulips, or Darwin Hybrid tulips at prices from $0.30 to $0.40 apiece, levels similar to post mania tulip prices in Holland.
Today, given the separation of time and space, we can safely characterize a tulip price of roughly $35,000 for a bulb as "crazy" and the behaviour of certain anonymous persons who dealt in such prices as madness. No living person nowadays has any financial or emotional capital invested in the notion that paying $35,000 for a tulip bulb might be wise.
In retrospect however, most would agree that the prices paid recently at market peaks for computer stocks, oil stocks, gold, silver, Japanese stocks, iPhones and biotech stocks were extremely high. Were those people crazy?
Garber, Peter M., Famous First Bubbles, in “The Journal of Economic Perspectives”, Vol. 4, No. 2 (Spring 1990), pp. 35-54.
Garber, Peter M., Tulipmania, in “Journal of Political Economy”, Vol. 97, No. 3 (Jun., 1989), pp. 535-560.
Goldgar, Anne, Flower Power: Tulipmania: An Overblown Crisis?, in “History Today”, June 2007; 57, 6, pp. 33-39.
Hirschey, Mark, How Much Is a Tulip Worth? In “Financial Analysts Journal”, Vol. 54, No. 4 (Jul. - Aug., 1998), pp. 11-17.blog comments powered by Disqus