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Market Mania: How obsession with tulips caused an economic crash

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Albert Einstein had once said: “Two things are infinite: the universe and human stupidity; and I’m not sure about the universe.”

Market Mania: How obsession with tulips caused an economic crash
Editor's Note: There are times when humans collectively start believing in notions about asset prices that are later proved to have been driven by herd behaviour rather than rationality. In financial market terms, they are called bubbles. In our new Market Mania series, we take a look at some of the greatest bubbles that existed in human history – the causes, the experience of living through them, the aftermath when the bubbles burst and the learnings one can draw.
Albert Einstein had once said: “Two things are infinite: the universe and human stupidity; and I’m not sure about the universe.”
This quote aptly sums up the ‘Tulip Mania’, that occurred in the Netherlands in the early 17th century. Whenever the topic of financial crisis and economic bubbles comes up, the story of the Dutch tulip bulb market bubble of 1637, also known as ‘Tulip Mania’, almost always finds a mention. It still ranks as one of the most famous market bubbles and crashes till date. The drama played out at a time when the Netherlands was embarking on its Golden Age. The sudden craze for the flower drove the value of the flowers to bizarre levels, with some specimens of single tulip bulbs trading for the price of upscale houses in Amsterdam.
So, how did an extraordinarily beautiful flower, of all things, become the centrepiece of this hysteria in the 17th century?
The history
Tulips, though commonly associated with the Netherlands, originated in the Middle East. Long before the Dutch went gaga over the flower, it had enchanted rulers of the Ottoman Empire. In 1554, Ogier de Busbecq, ambassador for the Holy Roman Emperor Ferdinand, sent the first tulip bulbs and seeds to Vienna from the Ottoman Empire. These flowers commanded the same exoticism that spices and oriental rugs did.
Though the Dutch were captivated by these flowers, they realised that tulips, courtesy their fragile nature, could scarcely be transplanted or even kept alive without careful cultivation. This made them resort to techniques to grow and produce the tulips locally, establishing a flourishing business. Carolus Clusius, a famed botanist, was among the first to cultivate tulips. He grew large crops of these flowers in the University of Leiden’s botanical gardens between 1593 and 1609.
The most popular variety of these flowers were those that had stunning, mosaic-like petals and took years to cultivate. These were expensive and, for many wealthy Dutch families, became a sort of status symbol. Those affluent families that did not have a collection of tulips were said be lacking in taste. Soon, the merchant middle classes too started emulating the wealthy families, with the result that demand for tulips increased. Cultivators of tulips had a field day and so did the traders dealing in the flowers
The mania
Even then, it seemed improbable that a flower could generate the kind of mania usually associated with precious metals or financial assets. At around the same time, the Dutch were putting together a framework for speculative trading by developing advanced financial institutions. Many traders began exchanging future contracts, which allowed them to first produce and deliver the products later.
Such a scenario allowed those farming tulips to grow their yields on the basis of demand. You may now wonder, how that could have led to a hysteria. Well, that also led to traders paying for large quantities of the flowers in advance — the flowers that didn’t actually exist! Around 1637, tulip bulbs’ price skyrocketed in response to the huge demand for them.
Amid the frenzy, people began staking everything for a bit of greenery, which did not have any intrinsic value. At the height of this the tulip obsession, the rarest tulip bulbs traded for as much as 10 times an average person’s annual salary.
By 1636, the demand was so high that speculators entered the Stock Exchange of Amsterdam for tulip bulbs and raised the prices by speculating on demand. The population, even to its lowest dregs, embarked on the tulip trade, and began minting money just by possessing some of these rare bulbs. It appeared that thereon, prices would only rise.
The crash
However, confidence tumbled soon. In February 1637, the bubble burst and prices fell drastically, leading to an economic crash. Many traders had bought the bulbs on credit, hoping to repay when they sold those at a profit. They were left holding a lot of flowers that nobody wanted, leaving them bankrupt. By 1638, tulip prices were back to normal.
Due to patchy historical evidence, it’s difficult to ascertain the reasons behind the collapse. However, it’s commonly believed that the bubble burst because of poor financial regulations, coupled with unrealistically high market prices. This was one of the first examples of a speculative bubble in history.
Today, the term “tulip mania” is used metaphorically to refer to any large economic bubble when asset prices deviate from intrinsic values.
Yet, the phenomenon did not critically influence the prosperity of the Dutch Republic, which was the world’s leading financial and economic power during the seventeenth century. The economy did not collapse, but hordes of people who had speculated and participated in the buying and trading became impoverished overnight.
The takeaways
“As long as you have markets, you'll have excesses. People went crazy with tulip bulbs. They went crazy with the South Sea Bubble, they went crazy internet stocks, they went crazy with the uranium stocks back when I was first getting started. I mean, you know, you're not going to change the human animal. And the human animal really doesn't get a lot smarter.”
—Howard Warren Buffett, American philanthropist and a grandson of Warren Buffett
It’s a great story and the reason why it’s a great story is that it makes people look stupid. But the idea that tulip mania caused a big depression is completely untrue. As far as I can see, it caused no real effect on the economy whatsoever.
—Anne Goldgar, historian, and author of the 2007 book, ‘Tulipmania: Money, Honor and Knowledge in the Dutch Golden Age’
It’s a fraud” and “worse than tulip bulbs”
—Jamie Dimon, chairman and CEO of JPMorgan Chase, while describing Bitcoin in September 2017
Substantial merchants were reduced almost to beggary, and many a representative of a noble line saw the fortunes of his house ruined beyond redemption.
—Charles MacKay, Scottish author in an 1841 account
In July 2017, billionaire Howard Marks, in a letter to investors, had compared the rise of cryptocurrencies to the Tulip mania of 1637, and told his clients to avoid high-flying digital currencies. (Page 17 of link)
 
 

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