Tulip Mania

 

By Wei-Ju Lin

When someone refers to or speaks about a classical example they refer to something that was so epic that ,“everyone”, when hearing about it should have some basic knowledge of the event. Some famous classics would be the World War, The Tale of Two Cities, Elvis, the 1995 Rugby World Cup even Star Wars. Therefore like every aspect of life, the financial sector too has it’s classic, one of which has its significant impact on the financial markets back then and still serves an important purpose today.

What purpose could classics have today? A lot may wonder, I, myself wonder about many things and this has definitely crossed my mind more than once. And only one answer fits the pattern, and that is, drum role please...if we have now past example to compare to how would we know if something is good or bad, if you have never been to Venice how could one say that it, indeed, smelled terrible? All jokes aside, the Tulip Mania was certainly one of these classics that all economists and academics refer to when they discuss the topic of a financial bubble.


The Tulip Mania basically refers to an event that originated in Holland during the 1630s, during a time when the common bulb flower was growing in favourable conditions, as well as producing rare strands of colourful patterns that were then seen as highly unique. What was then a mystery has now been solved and results have shown that these rare strands were all due to a virus mutation that existed and that were rarely seen and thus seen as high quality assets. Something surprising that I found in this statement was that our view of mutation these days are in simply not that “nice”,  yet our opinions were highly influenced by our ancestors and how they saw things to be normally. Yet, in something so silly as tulips flowers a mutation could been seen as valuable and so would pay dearly for it. The virus mutation of the flower was not the only reason the Tulip Mania became such a famous classic in financial history, the other more important factor was the extremely high prices that on would trade for these tulips during the 1636 to 1637. Prices that peaked to the value of a luxury house in Holland during that time for only a handful of bulbs and then suddenly for no apparent reason crashed, this may seem silly to most people, it certainly did to me, but during that time only the high to medium class people who were seen as financially stable would trade in financial markets and a house to them in those days is like the value of a laptop to us today. In other words, they had money to spare.

This marked the beginning of this all time favourite financial bubble. How would one classify an event as a financial bubble, one common definition is something that increases in size and pressure, in a limited space and eventually when the pressure is to much it bursts. A proper definition is “a situation in which temporary high prices are sustained largely by investors enthusiasm rather than consistent estimation of real value”. The only problem with the definition is the process of consistent estimation of real value, how would one achieve that? In our time we have many indexes and appendixes that is constructed through careful analysis of the sector market and al lot of raw data to give us a clear indication on how the market is doing. Back then all they had were their social connections and word of mouth. In any case, the demand for these rare and common tulips began to rise rapidly, but supply was fairly limited due to the fact that it took many years to produce a bulb not to mention the time it took to have these flowers bloom. The market for these flowers soon developed from over-the-counter to futures contracts to options contract, where people would pay now with the uncertainty of delivery.



According to many academics they were many theoretical reasons to why the Tulip Mania occurred and that is a whole other debate that people can get into, but one of the more important reasons, for me, was the responsibility of the social networking for traders during that time. Many of the traders back then were wealthy merchants and therefore had the own “click” back then. Usually merchants that they had business relations with, or relations through marriage or family relations. Together these merchants in a sense controlled the market, as they were the ones with the supply and they were also the demand. The formed colleges to trade between them and also had to pay an small fee of which contributed to food and drinks, all to better their relationships with each other. Due to the fact that these flowers were viewed as extremely valuable, it also functioned as a symbol of wealth and power. Due to the speculations of the value of these flowers many new entrants soon started to enter the market from different parts of Holland, soon forming their own local colleges of trade. Some may argue that the Tulip Mania was not a very big event as it was very localized, due to the local colleges. Therefore not many parts of Europe were affected by this financial bubble. To me it still is a very good example as it proves that irresponsible business decisions that were based on personal relationships, not always but sometimes, lead to losses.

Some blamed these speculations that surrounded the tulip market on the fact that a lot of merchants hard a lot of wealth as the were forming new contracts to trade with the East and West Indies back then, this only made the rich, richer. There was also no barriers of trade back then like we have today, and so allowing the bubble to get bigger. Some even blamed the irrational behaviour on the Bubonic plague that spread through the nation, which caused people to be more risky. In my opinion the financial bubble only occurred the way it did due to social networking and norms of the time. As everyone with wealth would want the symbol of wealth, and therefore without doing any research, only by the norms of those days, they would contract large number of bulbs in the future for a large sum of money, without certain of the quality of delivery. But because they were dealing with people of whom they have learned to trust, through other business transactions or family relations, the uncertainty for them seemed to mean nothing at all but something we pay for as investors today. And so it began, and soon after when they realized that delivery became a problem they wanted to sell their contracts. Once a seller in Haarlem agreed to sell his bulbs to the same person for up to 35% less than the lowest selling price, the word soon spread and the market was now an uproar with everyone trying to settle their contracts. As their were no barriers back then the court was unable to do anything about it and it was up to the sellers and buyers themselves to settle this dispute, buyers often getting back between 3 to 5% of the selling price agreed upon as a penalty.

In conclusion, in the financial world it is always important to have good social networking skills at it is very important that your investors trust you. Event after this whole episode of social irresponsibility of the Tulip Mania where the rich created this illusion of false value around the tulip bulb back then, we still do have bubbles in our times today as we realize that demand plays a huge role in pricing of shares and assets. Our responsibility as the future of the financial market is not only to increase peoples knowledge of the financial world but also not to spread false speculations that lead to irrational increases in prices of luxury goods with limited supply, but to value them to their fair value.

References:
van der Veen, A.M. 2009. The Dutch Tulip Mania: The Social Politics of a Financial Bubble.
Garber, P.M. 1989. Tulip Mania. The Journal of Political Economy, Vol. 97, No.3. (June.,1989), pp. 535-560.