INVESTOR’S NIGHTMARE: THE DUTCH TULIP MANIA By Shivangi Gupta from Amity Law School, Delhi
The story of the Dutch tulip mania is a cautionary tale. Believed to be the first example of an economic bubble, the Tulip mania occurred during 1634-1637 in Holland.
An economic bubble is a situation where there is a relatively high level of trading activity on a particular asset class at price levels that are significantly higher than their intrinsic values. In other words, a bubble occurs when certain investments are bid up to prices that are far too high to be sustainable in the long run.[i]
During the Dutch Tulip Bulb Market Bubble, at the peak of the market, a single bulb could be traded for an entire estate, while at the bottom; its value was similar to that of a common onion.
It all started quite innocuously during the Dutch Golden Age. Tulips, not being native to Holland, were introduced to the Dutch by the Ottoman Empire where they had been cultivated for decades prior. The novelty of the new flower made it widely sought after and therefore fairly costly. The impetus to the Tulip mania was actually a virus known as mosaic. The virus didn’t kill the tulip population, but caused multicolor patterns resembling ‘flames’ to appear upon the petal. These mesmerizing patterned tulips came in a large variety. The singularity of the designs increased the rarity of the flowers. Thus the diseased tulips became even more expensive as the tulips, which were already selling at a premium, began to rise in price according to how their virus alterations were valued. Consequently, tulip hybrids a.k.a Cultivars were cultivated by Dutch botanists to obtain more beautiful altered flowers.[ii] These Cultivars became a symbol of social status.
As time passed, through word of mouth, the trade grew out and by 1636, tulip bulbs were being traded on the stock exchanges of numerous Dutch towns and cities, encouraging all members of the society to speculate in the markets. The economic prosperity of Holland during the Golden Age enabled the general masses to spend an extra coin and participate in the tulip market.
By the 1620s, prices were already rising to astronomical levels. In the years that followed it became more and more apparent that the tulip bulbs (which are used to produce the tulip flower) themselves were priced more than the actual bloomed flowers. Speculators mounded the markets, trading the bulbs rather than the flowers, which resulted in a futures market. By 1633, the Dutch even began using the bulbs as a currency themselves as is showcased by numerous records of land properties being sold for bulbs. As the true bulb buyers (the garden centers of the past) began to fill up inventories for the growing season the supply of the tulips further depleted, resulting in an increase in scarcity and demand. Astonishingly, the originally overpriced tulips enjoyed a twenty-fold increase in value in the span of a month.
As is the case with economic bubbles, the prices were not an accurate reflection of the value of a tulip bulb. As people decided to sell and crystallize their profits, a domino effect occurred where more and more people tried to sell at decreasing prices. As the prices steeply declined people acknowledged the cataclysmic demise of the bulb trade which resulted in widespread hysteria, causing people to sell regardless of losses. Contracts were not honored and the country was immersed in pandemonium. The government attempted to salvage the situation by offering to honor contracts at 10% of the face value, but as the market plunged lower such restitution was rendered impossible. In the aftermath, no one emerged unscathed from the crash which was followed by depression.[iii]
The Tulip mania provides an illustrative lesson that applies to this day, the most important of them being that any asset is worth as much as the value it provides and no more. Markets can become irrational sometimes and asset prices can exceed their intrinsic values. However, sooner or later, the price of any asset will reflect its true value.[iv]
Though a tragically hilarious story, what makes The Tulip Bulb Mania a legend in investment circles, is the loss of rationality on the part of the investors. Tulip mania, being the first of the bubble that burst, provides a starting point in many case studies analyzing investors’ behavior, which can be exceptionally irrational at times. It has thus helped in the analysis of the economic bubbles that have been witnessed in the recent past such as the "Dotcom bubble" of the late 1990s that burst in 2001, and was followed by the “Housing Bubble”.
Disclaimer: The opinions expressed in the articles or any other publication are those of the authors. They do not purport to reflect the opinions or views of the Educoncours or its members.