Monday, June 16, 2014

Tulip Mania: The First Big Bust

Semper Augustus - a popular species
of tulip during the Mania
In 2008, a global recession hit the world hard. It is a fact in an economy that there are periods of highs and lows, booms and bust. Bursting bubbles were inevitable if an authority is not careful enough. Bubbles are characterize by rapid rise of prices of a commodity and its sudden deflation caused by different circumstances. In history, one of the weirdest but significant bubbles was started by a flower – a tulip.

Tulip Mania hit the commercial and maritime nation of Netherlands in the 17th century. The mania was driven by a decorative and a luxury flower, the tulip. But with basic economic principle of supply, demand, and prices, the event put on the spotlight the world of speculation. Another word for gambling, the Dutch placed their faith in a flower for a hope of bright future. But when it reached its limit, it brought down a whole economy with it.

The story of the Tulip Mania began in the small but powerful nation of the Netherlands. The Netherlands was just a young nation by the time of the mania. It just gained its independence from the Spanish King in 1581 under the leadership of William of Orange. With a shipping armada that dominates Europe, the Dutch immediately rose into prominence. At the center of this commercial empire was the once marshy swamp city of Amsterdam. In Amsterdam, capitalism and wealth was King, merchants profited from the armada of Dutch cargo vessels. And from this profits, wealth grew and grew. Many also received opportunities to change their lives for the better. And so, from this pool of new and vast wealth, gambling, speculation, and luxury, would brew a cocktail for a disaster.

What ignited one of the first major bust in history came from an unexpected source. Tulip was a flower that grew initially in Asia and Asia Minor. It was in 1559 when a Swiss botanist Conrad Gesner brought the first tulips to Europe from Constantinople. Because of its beauty and rarity, the fabulously rich went crazy for the new exotic flower. Including to the countries that was hit by the tulip bug was the Netherlands. In 17th century Netherlands, rich merchants were prepared to pay a high price for such a flower. When the rich showed interest, other members of the lower social strata joined the craze for tulip. Shop keepers, barbers, tavern owners, and even from the poorest sector of society joined the tulip trade. Tulip mania was on.

Prices of a tulip was not a joke. A price of a tulip bulb back then was about an equivalent $35,000 up to $100,000 in today’s money. To show how much it was, a books of Charles MacKay, The Memoirs of Extraordinary Popular Delusions, described the equivalent of tulip species called Viceroy to prices of commodities. A Viceroy tulip could buy the following:
Price (Florins)
2 Lasts of wheat
4 lasts of rye
4 fat oxen
8 fat swine
12 fat sheep
2 hogsheads of wine
4 tons of beer
2 tons of butter
1,000 ibs. of cheese
A complete bed
A suit of clothes
A silver drinking cup

Its prices were not fixed. As demands for such little supply of tulips increased, price were surely to soar. And so, buying a tulip bulb and selling it would create a huge profit and more importantly, instant wealth. And so those from the poor sacrificed so many just to enter the lucrative trade. They would do their best to get a loan by making their properties as collateral. Surely enough, some succeeded and inspired more to enter the trade.

In 1636, changes in the selling of tulips were made. Then, tulips were only sold in the months of June to September because it was the time when the bulbs appear and bloom. And so, money could only be made during the summer seasons. Changes were made to make the trade available throughout the year. Instead of cash for bulb transactions, contracts, which could be classified today as derivatives, were traded. Buyers during the non-harvest season speculated whether the prices would rise if the on season arrived. From this speculations, they would then decide whether to buy the contract or not. And when the season was on, it was only then that the buyer received its bulb. The price of the bulb he would pay was based on the price of the contract made during the auction during the off season. A buyer could make money if the market price of the bulb in the market was higher than the price of the derivative that was paid. This system stimulated more speculation and even further boosted the tulip mania. 

The tulip trade was so profitable that it spread not just in Amsterdam but throughout the whole Netherlands. In 1636, Tulip Mania reached nearby towns and major cities. Harlaem, Leyden, and Alkmar had local markets for tulips. Major port city of Antwerp also had its own tulip market. Common folks even made tulip auctions in local taverns and were called colleges. Many of the markets for tulips even began to generate jobs like being a clerk.

Prices of tulip contracts continued to soar if it was not on the faithful month of February in 1637. The prices of contracts rose to new staggering heights. In one auction, no one appeared to buy so much high priced contracts for tulips. And with no demand, prices tumbled. The bubble had burst. Suddenly high priced contracts became worthless piece of paper. News of the falling prices caused a panic, and people started to sell their contracts. However, no one was willing to pay so much for another tulip. Many people suddenly saw themselves bankrupt. The most affected were those of the poor that sacrificed so much. They immediately saw themselves in even worst condition because of the crash.

Auctioneers in towns and cities in Netherlands hit by the crashed prepared to make plans to alleviate the problem. In February 24, representatives from each town and city hit the mania met in Amsterdam. Eventually, after weeks, a temporary solution was made. All contracts made before the height of prices on November of 1836 were to be made nulled and void. And for those unlucky that had bought contracts after November, they would only need to pay 10% of the original prices.

The laid out formula did not alleviate the panic. Many demanded the government to act to solve the rising number of bankruptcies. Some went to the courts to terminate the contracts. However, their moves were futile as the courts saw the buying of tulip contracts as a form of gambling. They were powerless to null it. Debate on how to act continue for weeks and even months before a decision was made. In April 27, 1637, the government made a decision to null all contracts concerning tulips.

The damage created by the tulip mania was devastating. Many people saw themselves without a single property. It took decades after the mania for the Dutch economy to recover. As for the tulip industry, its cultivation in the Netherlands continued to grow. Even today, the flower itself became widely associated with the Netherlands.

The Tulip Mania was an important event in world history. It was the first well known economic crash that happened. It became an example of how over speculation and overvaluing such as a simple item could create such devastation. Tulip Mania was just only the first big bust that hit the world.
French, D. Early Speculative Bubbles & Increases in the Supply of Money. Alabama: Ludwig von Mises Institute., 2009. 

Hirschey, M. Tech Stock Valuation: Investor Psychology and Economic Analysis. California: Academic Press, 2003. 

Rapp, D. Bubbles, Booms, and Busts: The Rise and Fall of Financial Assets. New York: Copernicus Books, 2009.

MacKay, C. Extraordinary Popular Delusions and the Madness of Crowds. United States: Start Publishing LLC., 2012. 

Tassler, N. The Impulse Factor: An Innovative Approach  to Better Decision Making. New York: Simon & Shuster, 2012. 

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