Tulips for the price of gold - What was tulipomania?

Animal instincts cause that people from the beginning of time were often guided by two emotions: fear and greed. Fear kept people from doing something stupid, while greed drove humanity to take risks. The history of humanity knows situations when the aforementioned risk was excessive. Sometimes there are situations when a large part of people fall into great fear at the same time or go mad with greed. If the latter occurs, price bubbles may appear on the market. A price bubble can be very strange assets. A great example is the bubble from the first half of the XNUMXth century, when people speculated… tulip bulbs. They did not have a wider application in the then productive activity of humanity. Many have invested all their life's possessions for one reason - their price was rising. The madness of the XNUMXth century has been hailed as TULIPOMANIA.

It seems silly now, but this is where greed and fear come in. Initially, people may have scoffed at investing in tulip bulbs. However, when they saw that their neighbors had become rich from this practice, there was greed and regret for the missed opportunity. They say there's nothing worse than seeing your neighbor get rich faster than you. As a result, people who did not know about tulips bought them or contracts for their supply only in the hope that they would find a buyer willing to buy them back at a higher price in the future (the so-called greater fool game). Tulip mania was a social phenomenon and found numerous references in art. Images and satires have been created that refer to this madness. Although tulip mania has been perceived by the public as an example of speculative madness that has engulfed a large part of society, some researchers are of a different opinion. They believe that it was a limited speculative episode. In today's text, we will present both points of view.

Market environment

William I of Orange one of the founders of the United Provinces. Source: wikipedia.org

Beginning of formation  United Provinces (today's Netherlands) dates back to 1579. Then 7 provinces signed the "Union of Utrecht". It was a declaration of disobedience to Catholic Spain by the Protestant provinces of the Netherlands. The Union of Utrecht is a kind of response to the Treaty of Arras, where the southern, Catholic provinces of the Netherlands declared allegiance to Spain. A few years later, the Republic of the United Provinces was officially established, which for the next several decades waged a war with Spain for recognition of its independence. This conflict was later called the "Eighty Years' War". One of the "founding fathers" of the United Provinces was William I of Orange.

The United Provinces were Protestant, and for this reason they were a place of refuge for many people of similar faith. The refugees were looking for a region that would allow them to practice their faith. Among those fleeing were skilled workers, which allowed the Netherlands to stimulate economic development. In addition, the work ethic, which came from Calvinism, also helped. The Calvinists placed great emphasis on education and work. This allowed to increase labor productivity, which resulted in increased competitiveness on the European market. The united provinces also became a place where capital flowed from all over Protestant Europe. Amsterdam was becoming one of the financial centers of the Old Continent.

Logo of the Dutch East India Company. Source: wikipedia.org

It is worth remembering that the first half of the 400th century was a period called the "Golden Age" in the Netherlands. This was due to the fact that this country was the beneficiary of geographical discoveries. Merchants grew rich on trade with the Far East. It was estimated that one successful trade trip to Asia could bring profits of up to XNUMX%. The most important company in the world at that time was the Dutch East India Company. It was also the first publicly traded company.

The company had a state monopoly on trade with countries from the Far East. The spice trade was particularly profitable for the company, where the sale price of some products was 17 times higher than the purchase price. Economies of scale allowed the East India Company to compete with English, Portuguese and Spanish competitors. In addition, the Dutch company had its own fleet and army, which provided protection on sea routes. This reduced the risk of losses due to the actions of privateers and pirates. Thanks to this, in the XNUMXth century, investors appeared who profited from the increase in the price of Kompania's shares and the payment of dividends. Trade profits were reinvested in the business and partly used for consumption. The growing wealth of the society meant that the needs of households increased. Cities became more and more beautiful and the taste of the upper classes more refined. This also affected the gardens, which were one of the places where their status was manifested. One of the symbols of wealth at that time were tulips, which were an exotic, imported flower.

Tulips in Europe

For the first time tulips came to Europe in the XNUMXth century. Due to their original appearance, which did not resemble "ordinary" flowers growing in Europe, they were admired for their "exoticism". As a result, tulips found their way to the gardens of wealthy Europeans. So it was a luxury item. After some time, it became a status symbol. Rich people were often not lovers of these flowers. However, their possession was treated as the duty of every rich man "on the level". Also, the "aspiring middle class" wanted to appear richer than it really was. Thus, the main reason for buying these flowers was as follows - they confirmed social and material status. The growing popularity of tulips meant that interest in these flowers also reached the bottom of the social ladder.

Tulips are very sensitive to weather conditions. At the same time, in the XNUMXth and XNUMXth centuries, there was not as developed arable culture as it is today. Sometimes it happened that a large part of the tulips did not "live" to the next season. Dutch farmers developed techniques that would allow tulips to be grown in the Netherlands. The greatest contribution was made by the botanist Carolus Clusius, who developed the hortus academicus while working at Leiden University. Thanks to this, the first tulip variety was created that was able to survive cultivation in the north of Europe. As a result, more and more tulips of domestic production appeared.

Semper Augustus one of the most expensive tulips. Source: wikipedia.org

Farmers quickly realized that it takes 7 to 12 years to grow from seed, while the bulbs themselves flower within the next year. During flowering, the original bulb disappeared, but many smaller bulbs appeared next to it, which could become tulips the next season. For this reason, it was important to properly care for tulips and protect the bulbs in the right way. There have been situations when improper storage or infection with a virus affecting the bulbs caused a decrease in the supply of tulips in the next season.

It is worth remembering that the tulip season was very short. In the north, tulips bloomed between April and May. On the other hand, the care of the bulbs took place between June and September. For the rest of the year, florists or tulip dealers signed contracts with notaries to purchase tulips for the following year. These were, in effect, futures contracts.

It should be added that in the XNUMXth century the Dutch were considered masters in the field of finance. Amsterdam became the financial center of Europe. Thanks to the depth of the financial market (as for those times), a market was created on which it was possible to trade rights to purchase tulip bulbs.

Tulip market in the years 1634 - 1637

As flowers became more popular, tulip growers raised their prices. This was helped by a good economic situation, which was additionally supported by profitable trade with Asia. In 1634, demand for bulbs also began to be reported by French speculators who wanted to use price arbitrage to profit from the tulip trade. A steady rise in tulip prices continued until 1636. At that time, the increase in prices resulted from a faster increase in demand, which the supply could not meet.

In 1636 tulips were one of the most important exports (along with gin and cheese) of the United Provinces. It can be said that even then the Netherlands was becoming a "tulip hub" in Europe.

It is not surprising that the price of bulbs depended on the supply and demand for this commodity. It should be noted that the supply depended on the storage conditions of tulip bulbs and whether there was a blight that could decimate their number. Because it took a year for the supply to recover (to dig up new bulbs from tulips that had been planted), the price of flowers could fluctuate wildly with rumors about potential supply next season.

In November of the same year, a drastic increase in the prices of some tulip bulbs began. Very quickly, the prices of the most rare specimens began to reach prices exceeding hundreds of guilders. The speculative period was fueled by contracts for the supply of tulips for the new season. The Dutch called these contracts windhandel or "air trade". The name came from the fact that during the trade  none of the bulbs changed hands. Buyers could trade with leverage as they only had to pay a fee of 2,5% of the contract value. These contracts were not traded on the Amsterdam Stock Exchange but on the over-the-counter (OTC) market. It is worth mentioning that it was not a very liquid market. Rarely has a contract changed more buyers than three times. So it wasn't the trade we're used to today.

The peak of tulip mania occurred during the winter of 1636-1637. Some of the contracts changed buyers up to 5 times. This meant that on such an illiquid market there were willing people who believed that they could get rich very quickly on "buying dear and selling dearer".

It was a game of greater fool, two things were necessary:

• The influx of capital on the market,
• Keeping the faith that  prices can only go up.

Doesn't that sound familiar? With the increase in the price of tulip bulbs, there was a wealth effect. Wealthy homeowners with gardens who kept their bulbs for next season felt that their fortune was growing. Accounts from the time mention that some people hired security. It protected gardens and outbuildings from looters who wanted to easily obtain tulip bulbs and sell them on the black market. The market grew on the belief that the supply of bulbs in 1637 would be very low. As a result, there was a chance for a significant increase in prices. The higher the price increase, the more latecomers who wanted to join the increases.

Nothing lasts forever. As late as January, tulip prices were rising based on rumors about the prevailing blight affecting tulip bulbs. In February, it turned out that the impact of the blight has a limited effect on the supply of bulbs. The beginning of the loss of faith began in February 1637 in Haarlem. It was then for the first time that buyers did not appear at the auction of tulip bulbs. One of the reasons was the bubonic plague epidemic. The plague, coupled with a lack of faith in bulb shortages, caused the tulip market to collapse. The effect of the bursting of the bubble was a drastic drop in futures and spot prices. Many of the varieties have fallen by more than 99%.

The deterioration of the market situation meant that some buyers did not want to fulfill the signed contracts. A Dutch court has ordered a freeze on tulip bulb contracts. Each of the local courts, after examining the case, was to settle the disputes on its own. Agreements concluded after November 30, 1636 did not have to be honored. The purchaser of the contract only had to pay a few percent of the nominal value of the contract in order not to be obliged to buy the bulbs.

Tulipomania and market data - the problem with examining the phenomenon

"Anno 1637. De tulpenwindhandel" - Johannes Hinderikus Egenberger. Source: Wikipedia.org

Unfortunately, the XNUMXth century was not as advanced in terms of reporting market prices as it was after the Industrial Revolution. As a result, there is little data on the prices of tulip bulbs. For this reason, there is no precise data on when the bubble on the tulip market began and ended. Much of the pricing data comes from an anonymous satire called: Dialogues between Waermondt and Gaergoedt. The aforementioned satire was written just after the price bubble burst.

The reliability of this data is questioned by some historians. One of the economists - Peter Garber - collected data on the sale of 161 bulbs for 39 species of tulips. The data concerned the years 1633 - 1637. According to the economist, 53 of them were recorded in "Dialogues". Interestingly, out of 161 bulbs, the most data concerned February 5, 1637, when the bubble burst. From that day, the economist collected data on 98 transactions. In addition, the prices concerned various transactions such as trade "futures contracts", spot transactions, notarial sale by breeders, sale of bulbs for real estate. Thus, there was no homogeneous market for tulip bulbs, but rather a transaction between private individuals in a non-standardized market.

The madness of the crowds - the impact on the views of future generations

In 1841, the Scottish journalist Charles Mackay published a book "Extraordinary Popular Delusions and the Madness of Crowds". In it, he included several examples of market madness. Among them were the stories of the South Sea Bubble and the Mississippi Company deception. In addition, one example was tulip mania. The book set the tone for tulip bubble research for many years. For generations, the book has been scrutinized by both other economists and speculators who have learned from this book how to recognize periods of market madness and the subsequent period of panic and depression. Interestingly, Mackay's book was based, among others, on on Johann Beckmann's work "A History of Inventions, Discoveries and Origins". In this work, data on tulipomania were largely based on the "Dialogues" mentioned above.

READ THE REVIEW: Extraordinary Illusions and Madness of Crowds [Book]

According to Charles, even the very poor citizens of the Netherlands were engaged in speculating with these flowers during the tulip mania. In the book, there was information that people gave 5 hectares (12 acres) of land for a Semper Augustus tulip bulb. Others offered a basket of goods worth 2500 florins for a single Viceroy bulb. It was a staggering amount. A skilled worker could earn about 350 florins a year. According to the book, "tulip fever" affected every social stratum. The urge to speculate was further fueled by stories of people who got rich very quickly. The mood was very optimistic, some believed that people from all over the world at that time would buy tulips only in the Netherlands. However, these were dreams. The temporary appreciation of prices could not last forever, because it was very easy to grow more bulbs from the tulip you had. Thus, the Dutch monopoly could not last forever. What's more, these flowers came to the Netherlands from the Ottoman Empire. So there were other countries that could increase production, which would lower prices.

There are also anecdotes in the book that are unlikely to current researchers. One of them says that one of the sailors mistook a tulip bulb for a normal onion and ate it for breakfast. At the time of consumption, the value of such a tulip bulb could provide breakfast for the entire ship's crew all year round. According to this story, the sailor was to be held responsible and put on trial.

From the accounts quoted in "The Madness of Crowds" one can find traces of behavior typical of the period of market mania. Investors bought contracts for the purchase of tulips only to resell them at a higher price. They were not interested in physically owning the bulbs and planting them in the garden. What encouraged people to buy was the desire to get rich quickly. The longer this mania lasted, the harder it was to maintain. This was due to the fact that more and more capital was needed to maintain the upward trend in tulip bulb prices.

A new take on the tulip bubble

One of the more famous opponents of the standard view of this period in history was Anne Goldgar. The American historical believed that tulip mania affected a rather narrow group of people. Most of the stories, on the other hand, were part of reproducing exaggerated speculative stories. According to Goldgar, the onion trade was not as fluid as researchers in the 6th and 1637th centuries claimed. From the research on documents from the period, in her opinion, the tulip trade concerned mainly merchants and experienced craftsmen. However, it did not concern the elite of the then Netherlands. What's more, from the examined participants of the transaction, Anne managed to find only XNUMX rich people who in XNUMX (the year the bubble burst) experienced financial problems.

Currently, some economists and economic historians focus on finding rational reasons for the price increase. One reason for the sharp change in price is the impact of the 30 Years War. The reason could be the influx of optimism caused by the accession of the Netherlands and France to the Protestant party and the beginning of the occupation of the Spanish Netherlands. With the onset of the plague and the outflow of capital to finance the war, the market collapsed. The aforementioned reason poorly explains such a strong increase in bulb prices. The plague and wars may be one of the reasons for the significant drop in tulip prices.

Goldgar mentions that a similar change in flower prices followed a similar pattern later on. As an example, she gave hyacinths, which gained immense popularity in the 30th century. As a result, florists began a rush to buy bulbs of this flower to meet the demand. Initially, it ended with a significant increase in bulb prices. When the market was saturated, there was a shortage of people willing to raise the price further. The increase in supply led to a huge deflation in the prices of these flowers. In 99 years, the prices of the most expensive bulbs have fallen by XNUMX% from the price peak.

In turn, Peter Garber mentions that tulip mania, despite its limited impact on the economy and the financial market, had a strong impact on the awareness of people living in the times of the bubble and just after. To many religious, conservative thinkers, it was preposterous that the price of the bulb of a flower that blooms very quickly could be worth more than the work of an honest person for a whole year. For this reason, stories handed down from generation to generation warned against the madness of speculation. Therefore, stories about the consequences of mania have been exaggerated in numerous satires.

A critical look at the work of Anne Goldgar

Some researchers, however, are of the opinion that Goldgar's research cannot fully explain such large increases and decreases in prices. In particular, the theory corresponds poorly with some of the high increases in the price of ordinary tulip bulbs. There are economists who believe that the bubble in the tulip market was just an "echo" of the significant increase in the money supply seen in the Netherlands. Earl Thompson also felt that Anne's arguments failed to explain why some tulip bulbs had fallen as much as 99,999% in just a few months, when flower prices at the time tended to drop by as much as 40% during a bear market.

According to Thompson, one of the reasons for the sharp change in prices was government intervention, which resulted from the lobbying of flower dealers. As a result of persuasions from traders, the law on contracts for tulip bulbs was changed. Until now, contracts required the buyer to buy it back at a certain price. After the change in the law, the contract was just a buy option. Thus, formally, forward contracts (obligation to buy) were changed into options (right to buy). Failure to purchase was to result in the payment of a commission amounting to several percent of the contract value. Earl believed that some investors in the market knew about the change in the law, so they hoped that they could use financial leverage to buy tulips. They counted the future increase in bulb prices, knowing that they had only a premium paid and a "contractual penalty" worth a few percent of the contract to lose.

On February 24, 1637, the Dutch Flower Merchants' Guild announced that all contracts entered into after November 30 and before the opening of the stock market in the spring of 1637 would be interpreted as "contracts with no obligation to buy" if the buyer of the contract paid a small penalty to the seller of the contract (the bulb owner). Thus, the increase in futures prices was the rational behavior of speculators who knew that they would not have to buy bulbs in the future.

Tulip Mania: Summary

Tulip mania is one of the most famous examples of speculative fever in history. Interestingly, the game in "bigger fool" is still valid despite the fact that almost 400 years have passed since the tulip bubble. An example can be dotcom bubble or a decrease in the valuation of growth companies in 2022. In the 10th century, some merchants and speculators believed that the price of tulips would continue to rise, even though the prices of such tulips as Viceroy and Semper Augustus were valued for many years of work by a skilled worker. At the height of the bubble, the most valuable tulips were sold for 000 guilders, the equivalent of a mansion on Amsterdam's Grand Canal. Such prices could not be maintained indefinitely. Tulips are a common commodity, they are also easy to produce (in the long term). So it couldn't be worth that much in the long term.

Some scholars suggest that the actual extent of tulip mania was much less than in period descriptions. The fever was to affect only merchants and a small group of speculators. According to these researchers, the XNUMXth century secondary market was not as liquid as it is today, so contracts were rarely traded. In their opinion, the stories were exaggerated as part of educating future generations about greed and human stupidity. Even if tulip mania had a limited financial reach, it certainly affected the culture of the time. This can be seen in numerous paintings and satires from the era. Another lesson from this story is to put your emotions aside when investing or speculating. Playing the "bigger fool" you never know who he really is.