Economic Bubble: The Tulip Mania

Before we get into the story of The Tulip Mania, we ought to understand economic bubbles, what they do and how they come about?

A bubble is an economic cycle categorized by the rapid escalation of asset prices followed by a contraction. It is created by a surge in asset prices unjustified by the fundamentals of the asset and driven by excited market behaviour. When no more investors are eager to buy at the preeminent price, a huge sell-off occurs, triggering the bubble to deflate.

How a Bubble Works?

Bubbles form in economies, securities, stock markets and business sectors because of a change in investor behaviour. This can be a real change — as seen in the bubble economy of Japan in the 1980s when banks were partially deregulated, or a paradigm shift — which took place during the dot-com boom in the late 1990s and early 2000s. During the boom, people bought tech stocks at high prices, believing they could sell them at a higher price until confidence was lost and a large market correction, or crash, occurred. Bubbles in equities markets and economies cause resources to be transferred to areas of rapid growth. At the end of a bubble, resources are moved again, causing prices to deflate.

The Tulip Mania

In the 17th-century Netherlands was the perfect place for the Tulip Mania to break out. Newly independent from Spain, the Netherlands quickly became a major European power. Dutch traders were very successful, spreading wealth and an increasing demand for luxuries throughout the country.

Similarly, tulips are a perfect commodity for a futures market (when parties sign a contract to deliver specific goods or services for a set price at a specified time in the future). Since tulip bulbs can only be uprooted between June and September, all purchases outside this time frame took place as futures trades, where traders signed contracts to deliver at the end of the season. This means that as prices were soaring and deals made (sometimes even ten transactions per bulb a day), no bulbs actually changed hands.

As usual with financial bubbles, things got out of hand quite quickly. Botanists competed with each other, trying to cultivate more and more spectacular flowers. Semper Augustus was one of the most coveted cultivars during the craze. By 1637, prices were stellar. According to contemporary records, a whole house was offered for 10 bulbs of Semper Augustus. And the offer was refused in favour of a better one. Speculators rushed the market, selling all their properties and possessions to bid on tulip bulbs. During the last month of the bubble, prices skyrocketed by 1,100%.

In February 1637, the tulip bubble ruptured. Buyers began to stop fulfilling their contracts, and the whole artificially-generated craze came crashing down. Fortunes were lost overnight and the value of the tulip took a plunge into the ground (where it really belongs).

Some scholars argue whether the Tulip Mania was a real financial bubble, since its bust didn’t send the Netherlands into a full-blown economic crisis. Although the Dutch government had to intervene to save many investors, it’s true that the country’s economy as a whole didn’t suffer long-lasting consequences. And the tulip is still one of the things the Netherlands is best known for.

The story of the Tulip Mania may seem funny today. Who would give their whole house in exchange for a flower that blooms for a week? But bear in mind that it’s easy to be smart in retrospect. Recognizing a bubble and trying to stop it is a lot more difficult when it’s actually happening everywhere around you.