Tulipmania, Two Scenarios

 

When we think about a financial crash, the first things that come to mind are the 2008 crash, the Dot-com bubble, or the aftermath of the Bull Market of the Roaring Twenties. But let’s move way back to the 17th-century Netherlands. In this essay, I will discuss the origin, rise, collapse, and aftermath of the Tulip Mania, an event considered the very first speculation bubble. Let’s see how much damage a tulip bulb can cause.

In order to understand the origin of the problem, we must be familiar with the social and economic context of the Dutch Republic at the time. From the late 16th century, the Dutch Republic entered a Golden Age. As a leading economy in Europe, the Netherlands expanded its trade ventures, making the Dutch East India Company the biggest business in the world in the early 17th century. Along with The British East India Company, two giants dominated the cotton, silk, tea, art, and spice trade, turning it into a global industry.

Tulips were introduced in the Netherlands in 1593, arriving through the spice trading routes. Looking nothing like local flowers, they quickly gained popularity and became desired by the Dutch upper class. At the time, Tulips, recognized as a luxury product, became a status symbol. Interest in purchasing them grew, and so did the price. In the early 1600s, professional cultivators started growing tulips in the Netherlands, making it a brand-new, promising business sector that remains significant today. Due to its unique pattern, a type called “broken tulip” was especially popular and consequently the most expensive. During the next years, tulips became a major export product of the Netherlands to East India, with a projected profit of 400%.

The year 1634 is the beginning of a tulipmania period. The tulip trade was booming, and tulips became the most desired item on the market. Everyone, not only the upper class, wanted to own bulbs. According to the estimations of Scottish journalist Charles Mackay, based on information that one bulb could be worth as much as 5,000 florins and florins were coins made of gold, the price of more expensive bulbs could be estimated to be around 750,000 to 1 million dollars in today's money. Enough to buy a 4 room waterfront apartment in Amsterdam today; Safe to say it got a little out of control. Demand kept on rising, and the Dutch kept on cultivating. Regardless of the limited supply, the “gold rush” continued. At the time, you couldn’t trade bulbs on the stock exchange, but the bulb trading system began anyway. Amsterdam Stock Exchange, founded in 1602 and accompanied by the creation of the Dutch East India Company, started offering contracts. Instead of buying a bulb, you could buy an option to buy a bulb, simply meaning futures trading of tulip bulbs. Now, instead of trading bulbs, people had the possibility to trade a contract saying they owned an option to buy bulbs in the future. The forward market continued to grow, and the situation got even more out of hand when people decided not to pay for their contracts but just gave a promise of payment when they eventually sold a tulip. In this situation, you are dependent on the realization of a contract so the buyer can pay back previous sellers. Prices skyrocketed from late 1636 to early 1637, peaking around 5 February. Not only the rarest and most desired types of tulips, such as the previously mentioned “broken tulips,” with one called Semper Augustus on top, but also regular bulbs rose in value enormously.

Picture from Amsterdam Tulip Museum website

Now, to fully present the collapse and aftermath of Tulipmania, I will provide two theories:

At the peak, when it was finally time to start liquidating contracts on tulips, nobody seemed willing to pay that much. It was simply too expensive. With no potential buyers for overpriced products (tulip bulb contracts), prices plunged. A big part of this rapid decline was the fact that people had purchased bulbs on credit, with a plan to repay loans when they eventually sold their bulbs for a profit. But when prices started to decline, most were forced to sell previously purchased tulip bulbs at a lower price, sometimes not being able to sell them at all, leaving them with nothing. There was no legal basis for forcing buyers to honor the contracts, which only intensified the decline. In May, buyers could call off any still existing contracts for a fee of 3.5% of the price. It was over. Such a course of events would, in fact, make it the very first market speculation bubble. Excited buyers,

neglecting the reality of the situation, boosted the price of the tulip bulbs to the breaking point. Financial bubbles burst when expectations reach a tipping point: once enough people expect prices to fall, the supply of greater fools dries up. Does that explain the sudden collapse in prices in February 1637? Perhaps. Tim Harford for BBC, “Was Tulip Mania really the first great financial bubble?”

An alternative theory suggests a different reason for a price decline. A crash is known to have begun in Haarlem, one of the warmer cities in the Netherlands, where February was exactly a month of tulips bursting through the soil. Traders might have realized that they would have more tulips than they expected, meaning a sudden increase in supply. It would mean that the whole situation was not a burst of a speculation bubble but a result of the supply and demand law. And in this alternative theory, the ending is similar: There was no legal basis for forcing buyers to honor the contracts. Buyers ended up paying between 3 to 10%, while some of them didn’t pay at all.

 In conclusion, staying with the first theory, a general model of a financial bubble is very much applicable. First, investors lose track of reasonable expectations, which is followed by an upswing in the price of an asset. A positive trend continues, and price rises until investors realize that the assets they are holding are massively overvalued. The sudden decrease in demand is followed by a rapid price collapse. A good modern example of a similar situation could be a sudden peak and fall of NFTs' popularity. Tokens used to represent ownership of a digital image gained huge popularity between late 2021 and mid-2022. People inspired by celebrities and the rapid price increase of tokens started investing in NFTs. The price of some images went from a few hundred dollars to a few thousand, with the most expensive one being sold for more than $91.8 million. The most expensive examples are currently off the market, but NFTs traded in a bigger volume, for example, ones with a likeness of a monkey, experienced almost a 90% decline in value.

Focusing on the positives, both NFTs and tulip bulb price decline didn’t negatively affect the whole economy. They were responsible for a huge loss of value in a single sector and heavily affected people with big investments. In the Netherlands, the most exposed people were the ones holding contracts they paid for with cash and tulip growers who expected future contracts to be paid.