b-school, Business, Economics, History, MBA, Microeconomy

Bubbles I: Tulipmania, XVIIth century

I do not need to tell you what bubbles are: irrational exuberance leads to an inflation of prices, usually some kind of stock, expectations lead to greater expectations, until there comes a moment where people believe at the same time that assets are too high -much above value- but that they’ll keep skyrocketing. This contradictory belief leads to stubborn reality and, once you come to terms with it, prices crash, leading to a backslash in the percepti0n of price and value of speculative investments.

So it’s a matter of scarcity and demand. Scarcity leads to demand, and demand leads to scarcity, until craze comes.

Today I wanted to review one of the first paradigmatic cases of a bubble. Much is said today if this description is an ex-post judgement and it really wasn’t a bubble, but in any case, tulipmania is still a synonym for bubble.

lesson learned: don’t bet all your future into one flower

It all began in 1593 when the first tulips arrived to the Netherlands. They were new, scarce, pricey and everybody wanted one. And it had a maturity period: you bought the bulb and in time you’d have the flower, just like some investment. So people began buying more and more and prices soared.

In fact tulips’ bulbs had been introduced for medicinal uses, but beautiful tulips quickly became a distinctive and exclusive mark of beautiful gardens. And from that they became a mark on the social ladder: you had to have tulips in your garden if you wanted to be someone in the Dutch society.

One thing led to another. Bulbs were traded more and more. Prices multiplied: more than twenty-fold monthly increases. And, as it always happens, everybody wanted to invest: people became on debt to get rich and longtime accrued savings were transformed into bulbs.

object of greed and social desire

Of course value was not on the bulb itself, because the bulb wouldn’t produce anything. Value was speculative, and that meant that, to really earn something, you needed to find another buyer. With rising prices, the buyer’s base shrinked until it was too small. Maybe they thought that a bunch of wealthy foreigners would come and buy them all, but foreigners never came.

Instead there was a moment when people started worrying because selling them was getting more difficult: periods got longer, psychologically longer than whatever short term is.

And there was that contradictory thought that comes with all bubbles: this is too expensive but it will get even more expensive. Expectations of further risings and expectations of depreciation mixed. Until the first expectation overcomes the second: this is too expensive.

And bulb investors panicked. Specially when many realised they had traded lifelong savings for beautiful-when-flourished nonproductive bulbs. Wouldn’t you?

Too late as usual, even the Dutch state tried to intervene, proposing to cover contracts at 10% value. Of course that caused an immediate 90% drop-off. But the value punctured that 10% soil again and again and the bubble finally bursted. It happened in 1637. The bubble had lasted less than one year, some had won a lot of money, but the subsequent depression affected both winners and losers.

Did investors learn from this? I leave the question unanswered. For next post: Isaac Newton’s investments…


4 thoughts on “Bubbles I: Tulipmania, XVIIth century

  1. You’re right. There’s a big bubble here too. Today the ECB raised rates 25bp to 4 pct. as expected. That means we are closer to seeing the end of that one 😉

    Best regards

  2. D.T.L.F. @ INSEAD says:

    Change tulips for real estate, and Netherlands for US or metropolitan E. Asian cities/city-states. The next…wait, last…no, every bubble is there 🙂

    RYC: Since we’re throwing around aphorisms

    “He who is not prepared, is prepared for failure.”

    So I’m preparing, in my own twisted way, since there is the possibility of success, pero habrá una posibilidad de falta tambien.

  3. Pingback: The South Sea Company (or how Sir Isaac Newton spurned the dismal science) « Gabriel’s scarcity rent

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