You have probably heard about many market bubbles. They have happened often throughout recent history. But, do you know about the first bubble? In this explanation, you will learn about the earliest and also one of the largest-scale market bubbles known to this date: the Tulip Mania.
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The Tulip mania is one of the most well-known speculative bubbles in history. It started in 1634 when the price of tulips ramped up many times their actual value before taking a nose-dive and culminating in a market crash in February 1637.
Considered as the first-ever recorded speculative bubble in the world, Tulip mania remains to this day a powerful lesson about excessive greed and speculation.
A painting by Claude Monet depicting the Dutch tulip fields, Wikimedia Commons.
To understand tulip mania, we must first learn how tulips became a luxury trade item back in the seventeenth century in Europe.
Tulips originated in the Tian Shan mountain ranges and didn't arrive in the Netherlands until the end of the sixteenth century. The vividly coloured petals differentiated tulips from any flower known to Europe at that time and quickly turned them into a fashionable trading item among the rich.
Carolus Clusius was the botanist that pioneered the cultivation of tulips in the Netherlands. His fascination with the tulip led him to grow a private garden with many rare tulip types and spend his later years studying the mysterious phenomenon called ‘tulip breaking’.
Tulip breaking is when a tulip petal colour changes into a multicoloured pattern. Science later found out that the breakages were caused by a virus infection.
People in Holland and the rest of Europe were obsessed with the infected tulips, much more than they admired the normal ones. This ramped up their price, and many Dutch botanists competed with one another to breed new and more beautiful tulips, known as ‘cultivars’.
A picture of tulips infected with the tulip breaking virus, Wikimedia Commons.
At first, the cultivars were only traded among a small group of botanical hobbyists. Soon, the trade expanded and botanists began to receive buying requests from strangers in faraway lands. This gave birth to the tulip brokerages, and the whole tulip trading scene became more popular than ever.
One factor contributing to the popularity of tulips is The Dutch Golden Age which took place between 1588 and 1672.
During this time, art, science, and military flourished in Holland and the country was considered one of the most influential economies in the world. A group of the new-rich emerged, consisting of merchants, artisans, and tradesmen who wanted to prove their social status by owning luxury items1.
The mesmerizing beauty of multicoloured petals and the rise of the independently rich Dutch traders turned tulips into a fashionable trading asset.
The problem is that tulips can't be cultivated year-round. They only bloom between April and May for a few weeks and their dormant phase takes place between June and September when the bulbs can be uprooted and moved to another place.
As a result, the trading of tulips rarely happened on the scene. People would sign contracts to buy tulips during the last months of the year and collect them in the next summer. Before the actual transaction, the tulip contract could change hands many times2.
So far we have examined what turned tulips a fashionable trading asset in Holland and the rest of Europe during the seventeenth century. But what actually led to the tulip mania?
As tulips gained in popularity and demand grew, speculators entered the market. At first, the speculation was rationable with realistic expectations of tulips' profit growth. Soon, the matter got out of hand as a lot of buyers jumped in for fear of missing out.
This boosted the trading volumes and drove the price of tulips up many times their intrinsic value. At one point, people were willing to pay 100,000 florins for 40 bulbs — around 10 times the annual salary of a skilled worker3.
Illustration of a tulip from 1637, Wikimedia Commons.
This is known in today's terms as a speculative bubble.
A speculative bubble is a rapid climb in the value of an asset, driven by an exaggerated expectation of its future growth.
The tulip contract trading was dubbed as ‘wind handle’ as people didn’t receive any bulbs at the time of the purchase. Instead, people signed contracts to buy the tulips, then resold them for a higher profit. At its peak, the tulip changed hands ten times before the actual transaction.
Suppose you sell me a tulip for 2 guilders, I sell it to my brother for 10 guilders. My brother's friend is interested and promises to buy the tulip from him for 50 guilders and so on.
Due to the exaggerated expectations of profit returns, transactions bloomed and tulips became the fourth leading traded item in the Netherlands, after gin, herrings, and cheese.
Seventeenth-century illustration of the Semper Augustus, the most expensive tulip during the Tulip mania, Wikimedia Commons.
In 1637, the bustling tulip market deflated. Buyers came to their senses and decided they no longer wanted to pay for the highly overpriced tulips. Demand fell and the market collapsed. It started in Haarlem when people refused to show up to collect the tulips, partly due to the recent outbreak of bubonic plague, then spreading to other parts of the Netherlands and Europe.
The speculative bubble burst. Many people were furious as the tulips they owned were only worth a fraction of what they had paid for them. Amid the crisis, the Court of Holland ordered to freeze all tulip agreements. Some tulip growers pressed for full payments, though they eventually gave up the effort and reduced the price to the level that buyers could actually buy. The Tulip mania finally ended, but its impact on the Dutch economy lasted for many years.4
The Tulip mania not only left the state of the Dutch economy ruined but also destroyed people's trust and relationships.
Tulip mania is a classic example of a market bubble that happens in a cycle. This is better illustrated in the figure below.
Figure 1. Market bubble cycle, Alanna Odagbu - Vaia.
Despite the fact that the Tulip mania taught us of the dangers of inflating prices to irrational levels, throughout history, we still see this kind of story repeat itself. Most recently with the dot-com bubble and cryptocurrencies.
Perhaps the greatest lesson is that human behaviours are hard to change and our best hope is to equip ourselves with the knowledge to prevent ourselves and those around us from suffering when such a crisis happens.
Sources
1. Simon Schama, The Embarrassment of Riches: An Interpretation of Dutch Culture in the Golden Age, 1997.
2. Anne Goldgar, Tulipmania: money, honour, and knowledge in the dutch golden age, 2007.
3. Mike Dash, The Story of the World's Most Coveted Flower & the Extraordinary Passions It Aroused, 2001.
4. Charles Mackay, Memoirs of Extraordinary Popular Delusions and the Madness of Crowds, 1841.
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What is tulip mania?
Tulip mania, also known as the Dutch tulip bulb market bubble, is the earliest market bubble recorded in history. It happened mostly between 1634 and 1637 when the market collapsed.
At its peak, 40 tulips cost up to 100,000 florins, more than 10 times the average worker's annual salary at the time.
What were the economic effects of the tulip bubble?
As the popularity of tulips escalated, their price grew exponentially. Speculators entered the market in 1634 as a result of rising demands of the French. At its peak, the price of 40 tulips was 100,000 florins, and the contract trading hands changed 10 times per day. Tulips became the fourth leading trade article in Holland.
In February 1637, tulip bulb contract prices collapsed rapidly as buyers refused to show up to pay for the tulips. Demand dropped sharply after and the price plummeted.
What caused tulip mania?
As in any financial bubble, the tulip mania is the result of the investors’ irrational expectations for an asset's future price and the positive feedback cycle that kept the prices inflated.
When was the tulip mania?
The tulip mania happened mostly between 1634 and 1637.
What are the economic lessons from tulip bubble?
The biggest lesson from the tulip bubble is to be aware of speculative investments as the market can burst any time when the public comes to thei senses and realize the inflated assets are not worth as much as they predicted.
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