In the 17th century, the Dutch became obsessed with buying tulip bulbs. Prices of the then exotic and luxurious flower type skyrocketed to extraordinary levels, but in 1637, they came down tumbling, and the bubble officially popped. Also known as the ‘tulipmania’, it became the first-ever recorded asset price bubble, with the term now symbolic of the dangers of human greed and speculation. But was the tulipmania a classic case of an economic crisis or just a socio-economic phenomenon?
The Tulip Story
As a background, the beginning of the 1600s brought some period of rapid prosperity and hope for the Dutch Republic that had just gained its independence from Spain. With newfound resources that could be channelled into trade, there emerged a growing wealthy group of Dutch merchants who could bring in returns above 400% in just one voyage. Commerce boomed in the country, and this category of ‘new rich’ naturally wanted to acquire the taste and class of the nobility. Coincidentally, it is at this same period where the exotic tulip flower had grown to become an exclusive luxury item.
Tulips were native to Turkey, and central Asia, and they had arrived at the shores of what’s now Holland in the late 1500s. They were unlike any other native flower in Europe and were held in the high esteem accorded to exotic spices and oriental rugs. Part of the lily family, tulips were bulbous spring-flowering plants that had aesthetic looks and appeal, combined will bold, saturated colours. Add to that its incredible symmetry, and it is easy to understand why it was a standout staple in any garden worth its salt.
There were different types of tulips, classified by the colour of their petals. Professional cultivators soon discovered how they could develop multi-coloured strains, and rarest breeds of the flower commanded even higher prices in the market. As early as 1610, tulips had started to command higher prices, and there is a case of one bulb being exchanged for bride prices. Demand for rare types of tulips increased throughout Northern Europe, and international demand expanded. By this time, the tulips industry was not strictly regulated, and growers could easily enter the trade. This tulip trend continued and got entrenched in the Dutch culture even when the country’s economy became depressed following the resumption of war with Spain.
The Role of Speculators
During the 1630s, a new player entered the lucrative tulip industry: speculators. Tulips typically bloomed within one week in the months of April and May, but they could also be uprooted and transferred between June and September during their dormant phase. Contracts that mirror modern-day futures were initiated, and this finally allowed tulips to be traded throughout the year. The Dutch had enhanced financial structures, and standardised tulip contracts were launched as well as an innovative credit system.
People could procure personal loans, and not actually from banks, based on tulip promissory notes. The notes became a solid asset that could be used in the exchange of high-quality goods. This great financial innovation provided the much-needed liquidity for tulips to be financed from planting to flowering. But the promissory notes quickly became tools for speculation rather than tools for enhancing liquidity and credit in the tulip industry. Citizens of almost every level of Dutch society got involved in this speculation, attracted by the opportunity to make big and fast profits. By this time, all types of tulips (both common and rare) had seen their prices skyrocket to unimaginable levels, even attracting speculators who could afford ‘luxury’ items.
Bars, not Bourse
Typically, tulips were not traded on official exchanges. Rather, they were traded casually in local bars, and every trade celebrated with a toast. At the height of the tulipmania, a single bulb commanded a price as high as the equivalent of a mansion in the then prestigious address at Amsterdam Grand Canal. The bulb market reached unsustainable levels towards the end of January 1637, and a few florists began to sell without reinvesting again. Other florists took notice, and the unthinkable happened during the first week of February that same year.
On February 5th, 1637, at Haarlem (a popular auction site for tulips), the first offer for bulbs was floated but no bids were received. Offer prices were lowered, but there were absolutely no interested takers. And just instantaneously, there were no willing speculators to continue providing liquidity for the tulips trade. Word about the spectacular failure of the Haarlem auction quickly spread around, and highly leveraged speculators were gripped with panic. They quickly sought to liquidate their holdings, and prices continued to tumble drastically.
Literally, within a blink of an eye, tulips that managed to be sold at high prices now fetched prices of below 5% of their initial values. Contractual buyers still owed large debts to bulb holders due to their highly leveraged bets. With prices tumbling hard and fast, they hoped they would not be compelled to pay. With growers and contractual buyers failing to resolve their issues, the Central Government stepped in. Courts initially proposed that buyers and sellers agree on a 10% settlement but later banned all tulip cases, delegating them to local authorities in a bid to remain impartial. There were no clearly defined rules on bankruptcy or debt resolution, and eventually, contractual buyers and growers were forced to resolve their differences locally and individually. The blooming season was soon approaching, and growers were forced to accept any available ‘fire sale’ offers.
The Impact of the Tulipmania
The tulipmania has been recorded as one of the first-ever asset bubble price bursts, but accounts of its impact on the Dutch economy vary. One view is that it completely shook the economy as many people were involved in the tulip trade. Its high prices meant that when the bubble burst, many people saw their wealth slashed and their ability to spend limited.
But some believe that the impact of the tulipmania was not as devastating as it is made out to be. To start with, the tulipmania was not fuelled by speculation, rather by cultural factors. Tulips were a new plant for the Dutch, and their changing colours could only appeal to the people it was meant to – those accustomed to aesthetics. This could only be the wealthy in society keen to showcase their great taste, and not necessarily peasants or those in the lower rungs of society. Tulips were once exchanged for prices equivalent to high-end homes, and this is precisely the play that only the wealthy in society can engage in. It is therefore believed that what happened was merely a ‘culture shock’ as opposed to an economic crisis. The Dutch culture that was accustomed to reliable and trustworthy credit relationships now had to deal with an unfamiliar situation. It was the moral fabric that was at stake rather than a full-blown economic crisis.
Another factor that supports this theory is that the players in the tulip industry were contained among market participants. It is the florists, speculators, and growers that conducted financial activity amongst themselves, and they were never linked to the mainstream financial system by attaching credit to banks or any other formal financial institutions. This means that there were no economic shocks that overflowed to the mainstream economy. Additionally, tulips were only blooming during a small window every year. There were therefore, numerous speculators that bought bulbs that they never eventually paid for.
But why is the tulipmania so pronounced if it was never so serious in terms of impact? A possible explanation is that the advanced Dutch culture had storytellers or poets that exaggerated the ordeal for literal fun. It is indeed very possible that modern society easily ridicules the stupidity of those involved in past asset price bubbles.
Regardless of the truth about the tulipmania, there are lessons to be drawn from the bubble. Besides the dangers of greed and heightened speculation, the tulipmania clearly demonstrated the importance of regulation. The bubble was characterised by individual debt lending with no clear lender and borrower protection. Unlike the past, it is very possible for individual debtholders to be massively impacted by economic crises and spill-overs to be eventually felt in the mainstream economy. This is why current governments focus on consumer awareness and protection programs.
There is also the idea about refinancing debt – something that can ease panic during crisis situations in the economy. The panic witnessed within the economy emanated from just one auction failure. With debtholders protected or at least having options, such panic cannot easily arise or can be effectively managed if it is unavoidable. Furthermore, in modern society, regulators have established credit rating systems that can help promote healthy lending to qualified borrowers.
Ultimately, post tulipmania was not very depressing for the resilient Dutch economy that grew admirably thereafter. And despite different accounts on what exactly could have transpired, the tulipmania has remained a clear illustration of what can trigger asset price bubbles. The bubble has emphasised the need to control speculation as well as to enhance consumer protection.
A flower can bloom, but not every bloom is gold!