Over the Christmas break, I read Tulipomania, by Mike Dash. The book explores one of the first documented bubbles – and seeks to understand what happened beyond the traditional explanation of “the madness of crowds“.
The book is light enough reading. Dash writes in an accessible way, and avoids going into too much detail – the appendix, however, is full of annotations, sources, and further reading.
Tulipomania happened in the Netherlands in the 1630s. The United Provinces had declared independence from Spain, and was engaged in an 80-years war of independence. By the 1630s, the country had prospered despite the war, and a new class of wealthy merchants had arisen, benefiting from both overseas trade (the Dutch East India Company was one of the most powerful institutions in the world at that time), local manufacture powered by windmills, and an influx of protestant refugees from the Spanish-controlled provinces.
These merchants used their wealth to build gardens, and the tulip – recently introduced into Northern Europe from Turkey – became fashionable, at least in part due to a virus infection which caused flowers to display amazing patterns. As tulips could be harvested as bulbs, they traveled relatively well, and the flower was relatively easy to cross with other tulip varieties. The printing press allowed catalogues to be produced, and the canal system in the Netherlands allowed for relatively rapid communication between population centres.
Rich collectors paid large amounts for rare tulip bulbs – multiples of the annual salary of a working man, even before the mania set in. Word got about, and some people started to specialize as tulip growers; others started trading tulip bulbs. In principle, you can see the appeal – if you can get your hands on the bulb of a rare tulip, and get it to generate offsets, you could get two or more bulbs in a year’s time, and double your money.
An interesting point Mike Dash makes is the lack of investment opportunities for the “middle class” – workers with a decent income who wanted to better themselves had very few opportunities to invest their money, even though the Dutch Calvinist ethic strongly favoured saving. Dash believes that many people saw the investment opportunity of the bulb trade as a legitimate way to escape the restrictions placed on tradesmen by the guilds.
As rich collectors drove up the prices of the rare and beautiful tulips, more and more people got involved in the trade, driving up the price not just of the top quality bulbs, but every tulip variety, often by 200 or 300%. Dash describes many modern financial phenomena – a futures market, leveraged purchases, and of course the bubble. As bulbs were effectively a “future” contract for a flower, buyers could acquire a bulb for around 10% of the price of the flower. If you’re confident prices will rise, this allows you to buy a 1000 guilder bulb for 100 guilders, and sell it on for a profit before the bulb becomes a flower. The person you sell the bulb onto hopes to do the same – thus creating a long chain of people who make a paper profit from a single bulb.
Tulipomania drew in many people, and when the bubble burst, it burst quite spectacularly. Rare flowers dropped in price six fold; common bulbs pretty much lost their entire value. The interesting thing is how the government reacted. While tulipomania was taking hold, a stock exchange was being created in Amsterdam – the first in the world. It was strictly regulated, and only those with expertise and financial wherewithal could take part. When the tulip bubble burst, the government and courts effectively washed their hands of the whole affair. The courts effectively ruled that the tulip contracts were null and void – thus unwinding most of the trades. A compromise agreement meant that most traders could dispose of their obligations for a few cents on the dollar, and – remarkably, perhaps – there’s no evidence that the bursting bubble affected the real economy. There was no recession, no reduction in trade – the Dutch golden age continued unabated.
Dash’s book is an easy read – and it’s clear that it was written before the 2008 credit crunch, as the parallels are so obvious, any writer would be tempted to make comparisons.