During his interview with NPR in 2019, Robert J. Shiller described the Dutch Tulip Mania of 1636 as the original financial bubble that led one tulip to be worth “the same value as a whole house.” An individual Semper Augustus bulb sold for 5500 guilders (approximately 450 per ounce). Raymond James. Known as “forever exalted” in its original Latin, the Semper Augustus tulip was renowned for its apparent beauty. This was due to a viral infection of the petals. Originally from 16th-century Turkey, these tulips symbolise the purchaser's wealth and beauty. This association led to spectacular investments from citizens across the Netherlands and its neighbouring countries. Thanks to an expanding money supply with loose credit, many Dutch citizens could purchase tulips beyond their means, according to research from Doug French in the Quarterly Journal of Austrian Economics.
Scholars continue to debate whether the Dutch tulip mania qualified as a speculative bubble. According to Earl A. Thompson, tulipmania was not a bubble. Instead, the speculative frenzy illustrated the efficient market hypothesis in action since the prices that Dutch buyers were willing to pay were adequately reflected in the prices of the tulips. As Dutch buyers bet on the future prices of their tulips, they created futures contracts that attempted to predict the future price of their “securities,” in this case, tulips. For Thompson, these futures contracts increasingly became converted into options contracts as buyers, sellers, and speculators sought to protect themselves from the volatile world of tulip prices. Thompson argues that the reported prices of tulip bulbs during that period did not indicate irrational behaviour. Instead, they were an implicit conversion of futures contracts into options contracts. The buyers need not pay a significant premium to possess the tulips at a specified future date. Instead, they could exercise the “option” of holding the tulips intangibly.
In this blog piece, we will tell the story of this financial frenzy and let readers decide whether or not it was a speculative bubble.
Semper Augustus above
The origins of the tulip mania can be traced back to the late 1590s when a botanist named Carolus Clusius began to study tulips in his botanical gardens at the University of Leiden. He tried expanding the tulip collection in his garden and attracted wealthy merchants and aristocrats intrigued by the flowers' exotic beauty. Clusius’ involvement in tulip trading is beyond the botanical community. He had connections with government officials and influential merchants. It is believed that he shared the tulip bulbs with his acquaintances, further spreading the enthusiasm for tulip cultivation nationwide as a symbol of wealth and prestige.
Attracted to their exoticism and perceived prestige, the Dutch grew interested in cultivating and trading their own tulips. By the early 1630s, the market had evolved into a speculative bubble due to the increasing demand for rare and prized tulip bulbs and an ever-shrinking supply. The allure of quick profits attracted a wide range of investors, from wealthy merchants to commoners looking to capitalise on the tulip craze.
As the frenzy spread, Dutch botanists began to compete with each other to cultivate new hybrid varieties. This series of competitions later became known as the “cultivars.” As time passed, the trade grew out of the group, and botanists began to receive requests from people they did not know for the flowers, bulbs, and seeds in exchange for money. Tulip brokerages began to open up, and what was originally a “gentlemanly pursuit” turned into an all-out war for profits.
Thanks to a flourishing Amsterdam Stock Exchange that opened decades earlier, the Netherlands possessed the necessary financial framework to process the new tulip mania. Speculators piled into the markets like wildfire, trading the bulbs rather than the flowers, which resulted in a futures market. As the bulb price began to rise, less knowledgeable traders entered the market, causing a storm of irrational enthusiasm for the tulips.
The speculative fervour reached its peak in the winter of 1636 to 1637. Prices for tulip bulbs soared to astronomical levels, with some bulbs fetching prices equivalent to luxurious houses or a small fortune. The mania spread throughout society, and tulip trading became a popular topic of conversation in taverns, social gatherings, and marketplaces.
Monetary Environment of the Mania
The Bank of Amsterdam, functioning as the central trade point, played a crucial role in the Dutch monetary system. Its currency primarily consisted of foreign coins, many of which were worn and damaged, causing the devaluation of Amsterdam's currency. Consequently, introducing new coins into circulation became challenging, as they were quickly collected, melted down, and exported as bullion. This perpetuated a cycle where undervalued money was replaced by overvalued or degraded money due to its legal tender status. The Bank of Amsterdam issued bank money, known as credits, against deposits of coins, valuing them based on their metal weight rather than their face value. Due to its convenience, uniformity, and the city of Amsterdam's guarantee, the bank's money traded at a premium over coins.
The increased money supply resulting from free coinage, coupled with the overall economic growth and prosperity in the Dutch Republic, contributed to a speculative mindset among investors. Alongside a booming stock market and credit availability, individuals had greater access to capital, which could be used for speculative ventures. With more money circulating in the economy, the demand for tulip bulbs soared. Tulip bulbs became highly sought after, and their prices experienced rapid increases. The increased money supply was pivotal in fueling this demand, as investors now had the means to participate in the tulip market and drive up prices. Moreover, the availability of credit further intensified speculation during the tulip mania. The free coinage policy facilitated credit availability in the Dutch economy, allowing individuals and businesses to access funds for larger transactions. This accessibility of credit allowed investors to leverage their capital and engage in extensive trading activities, including tulip bulb trading. The combination of increased money supply and available credit created an environment conducive to speculation and investment, contributing to the euphoria and intense trading witnessed during the tulip mania.
The Psychological Influences Behind the Mania
One factor that contributed to the price dynamics during this period was herd behaviour, which occurs when individuals in a group act collectively without centralised direction. This led to social waste in the form of transaction costs and negative externalities to the gamblers' families and creditors, making the market substantially inefficient despite efficient market prices.
A satirical illustration of herd behaviour
Scholarly Interpretation of the Mania In analysing the phenomenon, it is important to address the significant price decline in October 1636, which Peter Garber overlooks. Following this decline, there was a 20-fold price rise and decline from early November 1636 to early May 1637 without any apparent changes in costs or utilities. These wild price fluctuations, occurring over six months, are a prime example of a market bubble. Garber's analysis fails to provide a rational explanation for this tulipmania. Contrary to the notion that the high-priced trades only occurred in taverns, Thompson highlights that similarly high-priced trades also occurred in regular auction markets. Additionally, he points out that taverns served as common sites for financial transactions during the cold winters of 17th-century Holland and that trading sessions in taverns followed formalised procedures. Therefore, these counterpoints undermine the argument that the inebriated amateur traders in taverns were solely responsible for the inflated prices. Thompson challenges the idea of labelling the boom and bust of the tulip market as a "mania" by emphasising that the price observations followed a series of fundamental shocks. He asserts that the efficient market prices observed before, during, and after the tulipmania reflected the underlying economics of the market, where options prices approximate the expected costs to the informed suppliers. This efficient pricing, despite the emotional exuberance and depression experienced by market participants, suggests that the price patterns were not substantially inefficient. Like Thompson, A. Maurits van der Veen also suggested that Tulip Mania did not produce a bubble. The tulip market was initially composed of knowledgeable aficionados who traded among themselves, primarily wealthy merchants with a thorough understanding of tulip growing and the characteristics of different varieties. The transactions took place during the flowering period, allowing buyers to assess the quality of the flowers firsthand. However, as the market expanded, attracting new, less knowledgeable traders, the introduction of new types of deals, such as trades based on bulb weights and bulk sales, further fueled speculation. The disconnect between specific bulbs and bulk contracts allowed for transactions where neither party knew the eventual source of the bulbs, diminishing the need for expertise in tulips or their bulbs. This shift attracted new entrants seeking quick profits, leading to an influx of speculators. Furthermore, external factors such as the flourishing Dutch commerce and the profits generated by the East India trade created a climate of increased wealth and risk tolerance among traders. The absence of guild control over the tulip trade and the free coinage policy of the Bank of Amsterdam further facilitated entry into the market. The devastating plague that swept through Holland in 1635-1636 may have also contributed to an inclination towards risk-taking, as the ever-present threat of death influenced people's behaviour. While the tulip market experienced a rapid rise in prices and an influx of speculative traders, it is crucial to understand that the bubble-like behaviour was limited to a specific period. The speculative frenzy reached its peak in early 1637, with prices skyrocketing and individual bulbs changing hands multiple times. However, the bubble burst abruptly, with plummeting prices and the market crash becoming apparent within a few days. One final contributing factor that deserves separate mention is the plague that struck Holland in 1635-1636, significantly impacting the tulip mania. The plague caused a devastating loss of lives, with Amsterdam losing approximately 20% of its population over two years and Haarlem, a major centre of the bulb trade, losing over 20% in 1635 alone (Noordegraaf and Valk 1996). Interestingly, some contemporary authors even linked the tulip craze to the outbreak of the plague itself (Theunis Zoon van der Lust 1637). However, recent analyses suggest a different perspective, proposing that the constant threat of sudden death may have influenced people to engage in greater risk-taking behaviour (Garber 2000, Goldgar 2007).
Reference list
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