Reading 2

Unit 6- Reading 2

Page 88

Tulipomania

One of the most entertaining chapters in Charles Mackay’s classic Extraordinary Popular Delusions and the Madness of Crowds (1841) concerns a speculative bubble that occurred in the Netherlands in the 1630s.

What makes this bubble such a curiosity is that it concerned, of all things, tulips, a variety of flower grown from bulbs and noted for their vivid colors and striking patterns.

According to Mackay’s account, in the mid-to-late 1500s, tulips from Turkey made their way to Amsterdam, where they grew in popularity among wealthy people who would pay extravagant prices for the rarer varieties.

The desire to possess them spread to the middle classes, and apparently people would spend a fortune to acquire a single root. The business in tulip bulbs was so great that by 1623 a single bulb could easily cost as much as a year’s salary. And the rarest bulbs by 1635 could fetch as much as 40 times that.

If Mackay’s figures are correct, a single bulb of the prized Admiral Liefken variety was worth as much as 19 tons of butter or 440 “fat sheep.” Apparently, owning such a prize denoted wealth and prestige.

Mackay enlivens his account with amusing anecdotes.

A sailor, while delivering merchandise, idly stole a bulb of the prized Semper Augustus variety from a merchant, and thinking it was an onion, ate it along with a fish that the merchant had given him. The sailor was quietly sitting on a coil of ropes finishing the “onion” when the merchant finally caught up with him.

In another episode, a visiting amateur botanist saw an interesting-looking root lying in a wealthy Dutchman’s home. Unable to suppress his curiosity, he cut up the pricey Admiral Van der Eyck tulip to study it. The confused botanist, after being dragged by the collar to the local courthouse, found himself in prison until he could raise money to cover the owner’s loss.

To accommodate the lively market for tulips, by 1636 several exchanges were established where buyers and sellers could acquire futures contracts (a promise to buy or sell a specified amount at a preset price). By buying and trading such contracts, tulip traders sought to profit from the fluctuation in tulip prices and grow instantly rich. The availability of easy credit and loans also facilitated buying.

Similar to the “day-traders” during the dot-com craze of the late 1990s, who quit their jobs, borrowed money, and used their personal computers to trade volatile Internet and technology stocks, people converted their houses and land into cash in order to invest in the flowers. In small towns, taverns served as the local tulip commodity exchange.

But it was not to last.

According to Mackay, once ordinary people bought tulips to sell for profit and not for planting in rich people’s gardens, the price was bound to drop as the foolishness of it all became apparent. In late 1636, prices peaked and fell sharply. Sellers panicked and sold at any price, buyers defaulted on their futures contracts, and the easy credit that buyers could count on to fund their purchases dried up.

Those who got out early ended up quietly rich, but many who believed themselves instantly rich were ruined. Mackay says commerce “suffered a severe shock,” and took many years to recover.

Mackay’s famous account serves as a warning to all those who speculate in stocks, real estate, or commodities As investment brochures routinely say, “Past performance is no guarantee of future returns.” But did Mackay exaggerate?

Was this really an extraordinary delusion and an example of the irrationality of crowds? Or was he too anxious to find another instance of what he called “the great and awful book of human folly”? Did the 17th century speculation in tulips really do long-term damage to the country’s economic infrastructure?

Recent writers and researchers have raised doubts about the scope of this bubble and believe a more accurate history of the period better clarifies the reasons it occurred. In his book Tulipomania (1999), Mike Dash agrees the Dutch tulip market was a speculative bubble driven by inexperienced investors. But he also reveals why rational people might have become caught up in it.

The flowers had unique color patterns much in demand for their beauty, but each new variety had to be propagated from a single bulb which could only produce two bulbs in the next year, four after that, and so on. When the available quantity was small, naturally the underlying value of a single bulb increased. The more abundant varieties sold cheaply by the pound.

To complicate matters, the gorgeous markings on the most striking bulbs were actually the result of a virus. That made them sickly and difficult to propagate. This biologically-determined rarity added to their value and kept prices higher than would normally be expected. Until 1634 or so, tulip prices behaved normally, with rare, slowly propagating varieties more expensive than the plentiful varieties.

But how do we explain the 20-fold increase in price before the 1636-37 crash? Isn’t such an increase a sure sign of speculative madness? Researchers point out that Mackay’s account leaves out mention of two events that may account for some of this fluctuation. In 1636-37, the bubonic plague struck the Netherlands, an event that must have had some effect on the collapsing prices of a luxurious commodity.

Mackay also neglects to mention the Thirty Years War in Europe. According to Thompson and Treussard of the University of California at Los Angeles, this devastating conflict played havoc with tulip demand. In the early 1630s, after stabilizing victories, tulip sales rose in Germany, where they grew well, but the tides of war changed in l636.

Sales in Germany dropped, and gardens were literally dug up to sell the bulbs to raise cash.

Thompson and Treussard place much of the blame on government policies. As the market fell due to plague and war, the government allowed speculators to convert their futures contracts from an “obligation” to buy into an “option” to buy. In effect, sellers could not force buyers to honor their contracts.

Without futures contracts to protect themselves against price drops, holding tulips became riskier and the price dropped accordingly. Thompson and Treussard caution against the “popular delusion” conclusion of Mackay and say “tulipomania” was actually an example of how market forces efficiently react to sudden changes in the prospects for profit and loss.

Dash’s book also makes it evident that, like the relatively mild recession following the burst of the dot-com bubble, tulipomania’s economic impact was minor since only a fraction of the economy was devoted to tulip trading, with the Amsterdam exchange and others wanting no part of it.

Not all observers are willing to dispose of Mackay so readily.

Kim Phillips-Fein, an ideologically motivated critic of market-based economies writing at the height of the dot-com bubble, complains that “trendy academics like to say that the tulip craze wasn’t a bubble at all.” Favoring market-driven economies, these researchers too easily dismiss the dangers of what she feared was a forthcoming economic disaster in western economies.

Meanwhile, “contrarian” investors will most likely continue to use the tulip history to warn investors against a “herd mentality” that encourages people to buy overpriced stocks. And professional investors and financial analysts will point to tulipomania as a warning of what happens when amateurs make their own investment decisions.

Without a clear, agreed-upon chronology of events that led to the stunning rise and fall of tulip prices, we may never know the causes with any certainty, and any explanation may reveal more about the researcher’s ideological bias than it does about Dutch life in l636. Was tulipomania an example of mass hysteria and human foolishness? Was it an early indictment of market-driven economies?

Is it a textbook example of how markets correct themselves, and is a warning to governments not to interfere lest they compound the problem? Or is it simply a blip in history—where greed, fear, opportunity, a love for beautiful things, and bad luck converged to produce an improbable outcome?

Are there modern parallels? Tulips seem reasonably priced today, but what about star athletes?

In the 1990s, the Chicago Bulls professional basketball team paid Michael Jordan tens of millions of dollars each year to play. Risky? Yes. But Jordan brought them six championships. In the 2010-2011 season, 25 players in the National Basketball Association earned $15,000,000 (U.S.) or more per season.

Only one, Dirk Nowitzki of the Dallas Mavericks, played for a championship team. Hoopimania,” perhaps?