If you have ever watched the famous movie Wall Street and remember the main character Gordon Gekko, you probably remember hearing about the Tulip bubble. In order to fully understand this important historical story it’s necessary to understand both the flower itself and the economic environment that was taking place at the time. Let’s explore the flower first.
There are over 150 species of tulips with over 3,000 different varieties. Tulips are not easy to breed, in fact it can take a decade for a seed to turn into a flower and that flower only lives for up to three years. Each tulip will produce only a few offspring/seeds which will again take ten years to become a Tulip flower. It is possible to make clones of each flower and reproduce a new flower in 3 years instead of ten. All of this work to produce a flower that only blossoms a few weeks out of the year between March and May. Now not only does it take time and effort to make a Tulip but once they bloom you can not move them or they will die, in fact you have to wait till the flower completely recedes into the bulb below ground before you can touch it, then only during the time between June and Autumn can the bulb be moved to be replanted. This means that there is an extremely short period for the bulbs to be sold on the open market.
The tulip bulb was first popularized by the Ottoman empire in 1718, this time is actually known as the Tulip period, tulips were cultivated and grown there and seen as a sign of nobility and privilege during a time of economic growth and prosperity. During this time the Dutch were experiencing a period of prosperity as well, one that came to be know as the Dutch Golden Age. This was a time of great importance for the Dutch people and a few major events happened that allowed the Tulip Mania to happen. First the Dutch people won a war against Spain and claimed their independence, this war also left them in control of some very important shipping ports. Second they became huge players in the shipping of goods from the east and this not only brought new products to sell but brought new merchants and tradesmen to the area in hopes of striking it rich. There was a company formed known as the Dutch East India Company that was actually the first publicly traded company to offer shares to the public, this company was able to establish a monopoly on the Dutch trade with East India and created an extremely prosperous time for traders and shareholders, before the establishment of this company it was hard for anyone other than the ultra wealthy to partake in the business of global trade and even for them it was a very risky venture due to the potential loss of entire shipments as a result of pirates or storms. The huge success of the new trade allowed for the establishment of the Bank of Amsterdam which only served to increase economic growth with the availability of loans to start businesses or invest in others. So we now have a highly sought after flower that is extremely hard to grow and seen as a symbol of wealth coupled with a booming economy and a rising middle class eager to show of their new found wealth. Hmmmm, sounds like a recent event in America with the housing crash, but back to the story. So just how exactly did a flower become so over valued, let’s examine.
We now have an environment that is ripe for a bubble, but how did it happen and what caused it to burst? We know that the Dutch merchants began importing Tulips for sale to the growing middle class and that the Tulip became a symbol of prosperity and affluence in the Netherlands just as it had in the East, but that is not what caused the bubble. Bubbles are caused by speculation and easy access to credit, which during this time everyone had. The Dutch people seeing everyone doing so well and spending money freely did just as Americans do and assumed that good times would continue forever. Many started to speculate in stock of the public company and bought shares in hopes of selling to someone else for a profit, the same happened for the tulip. All tulips were highly sought after but some had very rare colors and patterns which were considered even more valuable, ironically we now know that this was actually due to a disease the flowers were suffering from, these flowers were so rare at the time that everyone wanted to own one and that alone drove the prices higher and higher. It reached a point where a gardener who was lucky to produce a patterned tulip could sell that one flower alone for several times the price of the whole cost of the garden itself, but wait there’s only one problem, remember you can’t actually move the flower or it will die, which makes it worthless, so the gardener would actually sell the right to the future bulb once the flower retreated. This produced the first derivatives in the market as merchants would buy the right to the bulb now but wouldn’t gain access to it until later, they did this knowing that they could sell it for a profit later, however as the market became more and more popular that right to the bulb would trade hands multiple times before the bulb was even ready to be moved. This created a huge problem, people were no longer buying the future right to the flower because they wanted it in their garden, they were buying it in hopes of selling it to someone else at a higher price, this practice became so widespread that everyone wanted in on the action and began taking out loans to participate. At the time it didn’t seem like such a bad idea to take a loan for $25 dollars because you could just sell it for $50 and pay the bank back, unfortunately the flood of debt only caused the prices of bulbs to greatly increase and there could be multiple people holding loans on the same bulb. In fact the prices of flowers eventually exceeded the price of many homes, once again not for the flower but for the hope of making a profit. Unfortunately there is actually a limit to what even the most wealthy people are willing to pay for a flower and that is when and where a bubble is created and all we need for the bubble to POP is for people to give an indication that they are no longer willing to purchase something, then the holders of the loans rush to sell the contract and are willing to take much less just to recover their initial investment, this floods the market, which creates more supply than there is demand, which causes the price to drop even more. Once banks see this they begin to call the loans for repayment which the people are obviously not able to pay, and since the loans are not made against a tangible asset the banks are forced to go after other assets to recover their money, this puts and even further strain on the economy which is felt by the merchants selling other types of good as well. Eventually the whole Tulip market crashed and the prices dropped to a small fraction of what they were.
We have seen this same scenario take place several times, once with real estate as people were buying homes not to live in but simply in hopes of selling them to someone else. I remember while living at the beach during the height of the housing bubble and seeing new condo developments that would have condo units sell multiple times before the building was even finished. We saw another recent example with the popularity of BITCOINS, people began purchasing them not to use as currency but as an investment or speculation. We should all remember the wise words of one of the best investors of our time,
“Be Fearful when others are greedy and greedy when others are fearful.”
Thanks for reading,