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anti-speculative

Tulip mania

Tulip mania or tulipomania (Dutch names include tulpenmanie, tulpomanie, tulpenwoede, tulpengekte, and bollengekte) was a period in the Dutch Golden Age during which contract prices for bulbs of the newly-introduced tulip reached extraordinarily high levels and then suddenly collapsed. At the peak of tulip mania in February 1637 tulip contracts sold for more than 20 times the annual income of a skilled craftsman. It is generally considered the first recorded speculative bubble. The term "tulip mania" is often used metaphorically to refer to any large economic bubble.

The event was popularized in 1841 by the book Extraordinary Popular Delusions and the Madness of Crowds, written by British journalist Charles Mackay. According to Mackay, at one point 12 acres (5 ha) of land were offered for a Semper Augustus bulb. Mackay claims that many such investors were ruined by the fall in prices, and Dutch commerce suffered a severe shock. Although Mackay's book is a classic that is widely reprinted today, his account is controversial. Modern scholars believe that the mania was not as extraordinary as Mackay described; some suggesting that no economically meaningful bubble occurred.

Research on the tulip mania is difficult because of limited data from the 1630s—much of which comes from biased, anti-speculative sources. Rather than a speculative mania, some modern economists have proposed rational explanations for the high prices, although these explanations are not universally accepted. For example, other flowers, such as the hyacinth, have also had high prices on the flower's introduction, which then fell dramatically. The high prices may also have been driven by expectations of a parliamentary decree that contracts could be voided for a small cost—thus lowering the risk to buyers.

History

The tulip was introduced to Europe in the mid-16th century from the Ottoman Empire, and became very popular in the United Provinces (now the Netherlands). Tulip cultivation in the United Provinces is generally thought to have started in earnest around 1593 after the Flemish botanist Charles de l'Écluse had taken up a post at the University of Leiden and established the hortus academicus. There, he planted his collection of tulip bulbs—sent to him from Turkey by the Emperor's (Ferdinand I, Holy Roman Emperor) ambassador to the Sultan, Ogier de Busbecq—which were able to tolerate the harsher conditions of the Low Countries, and it was shortly thereafter they began to grow in popularity.

The flower rapidly became a coveted luxury item and a status symbol, and a profusion of varieties followed. They were classified in groups; one-coloured tulips of red, yellow, or white were known as Couleren, but it was the multicoloured Rosen (red or pink on white background), Violetten (purple or lilac on white background), and, to a lesser extent, the Bizarden (red, brown or purple on yellow background) that were the most popular. These spectacular and highly sought-after tulip bulbs would grow flowers with vivid colors, lines, and flames on the petals, as a result, it is now understood, of being infected with a tulip-specific virus known as the "Tulip breaking virus", a type of mosaic virus.

Growers named their new varieties with exalted titles. Many early forms were prefixed Admirael "admiral", often combined with the growers' names—Admirael van der Eijck was perhaps the most highly regarded of about fifty so named. Generael "general" was another prefix which found its way into the names of around thirty varieties. Later came varieties with even more superlative names, derived from Alexander the Great or Scipio, or even "Admiral of Admirals" and "General of Generals". However, naming could be haphazard and varieties highly variable in quality. Most of these varieties have now died out, though similar "broken" tulips continue in the trade.

Tulips grow from bulbs, and can be propagated through both seeds and buds. Seeds from a tulip will form a flowering bulb after 7–12 years. When a bulb grows into the flower, the original bulb will disappear, but a clone bulb forms in its place, as do several buds. Properly cultivated, these buds will become bulbs of their own. The mosaic virus spreads only through buds, not seeds, and so cultivating the most appealing varieties takes years. Propagation is greatly slowed down by the virus. Tulips bloom in April and May for only about a week, and the secondary buds appear shortly thereafter. Bulbs can be uprooted and moved about from June to September, and thus actual purchases (in the spot market) occurred during these months.

During the rest of the year, traders signed contracts before a notary to purchase tulips at the end of the season (effectively futures contracts). Thus the Dutch, who developed many of the techniques of modern finance, created a market for durable tulip bulbs. Short selling was banned by an edict of 1610, which was reiterated or strengthened in 1621 and 1630, and again in 1636. Short sellers were not prosecuted under these edicts, but their contracts were deemed unenforceable.

As the flowers grew in popularity, professional growers paid higher and higher prices for bulbs with the virus. By 1634, in part as a result of demand from the French, speculators began to enter the market. In 1636, the Dutch created a type of formal futures markets where contracts to buy bulbs at the end of the season were bought and sold. Traders met in "colleges" at taverns and buyers were required to pay a 2.5% "wine money" fee, up to a maximum of three florins, per trade. Neither party paid an initial margin nor a mark-to-market margin, and all contracts were with the individual counterparties rather than with the exchange. No deliveries were ever made to fulfill these contracts because of the market collapse in February 1637. This trade was centered in Haarlem during the height of a bubonic plague epidemic, which may have contributed to a culture of fatalistic risk taking.

The contract price of rare bulbs continued to rise throughout 1636. That November, the contract price of common bulbs without the valuable mosaic virus also began to rise in value. The Dutch derogatorily described tulip contract trading as windhandel (literally "wind trade"), because no bulbs were actually changing hands. However in February 1637, tulip bulb contract prices collapsed abruptly and the trade of tulips ground to a halt.

Available price data

The lack of consistently recorded price data from the 1630s makes the extent of the tulip mania difficult to estimate. The bulk of available data comes from anti-speculative pamphlets by "Gaergoedt and Warmondt" (GW) written just after the bubble. Economist Peter Garber collected data on the sales of 161 bulbs of 39 varieties between 1633 and 1637, with 53 being recorded by GW. Ninety-eight sales were recorded for the last date of the bubble, February 5, 1637, at wildly varying prices. The sales were made using several market mechanisms: futures trading at the colleges, spot sales by growers, notarized futures sales by growers, and estate sales. "To a great extent, the available price data are a blend of apples and oranges," according to Garber.

Mackay's Madness of Crowds

Goods allegedly exchanged for a single bulb of the Viceroy
Two lasts of wheat 448ƒ
Four lasts of rye 558ƒ
Four fat oxen 480ƒ
Eight fat swine 240ƒ
Twelve fat sheep 120ƒ
Two hogsheads of wine 70ƒ
Four tuns of beer 32ƒ
Two tons of butter 192ƒ
1,000 lbs. of cheese 120ƒ
A complete bed 100ƒ
A suit of clothes 80ƒ
A silver drinking cup 60ƒ
Total 2500ƒ

The modern discussion of tulip mania began with the book Extraordinary Popular Delusions and the Madness of Crowds, published in 1841 by the Scottish journalist Charles Mackay; he proposed that crowds of people often behave irrationally, and tulip mania was, along with the South Sea Bubble and the Mississippi Company scheme, one of his primary examples. His account was largely sourced to a 1797 work by Johann Beckmann titled A History of Inventions, Discoveries, and Origins. In fact, Beckmann's account, and thus Mackay's by association, was primarily sourced to three anonymous pamphlets published in 1637 with an anti-speculative agenda. Mackay's vivid book was popular among generations of economists and stock-market participants. His popular but flawed description of tulip mania as a speculative bubble remains prominent, even though since the 1980s economists have debunked many aspects of his account.

According to Mackay, the growing popularity of tulips in the early 1600s caught the attention of the entire nation; "the population, even to its lowest dregs, embarked in the tulip trade". By 1635, a sale of 40 bulbs for 100,000 florins (also known as Dutch guilders) was recorded. By way of comparison, a ton of butter cost around 100 florins, a skilled laborer might earn 150 florins a year, and "eight fat swine" cost 240 florins. (According to the International Institute of Social History, one florin had the purchasing power of €10.28 in 2002.)

By 1636, tulips were traded on the exchanges of numerous Dutch towns and cities. This encouraged trading in tulips by all members of society; Mackay recounted people selling or trading their other possessions in order to speculate in the tulip market, such as an offer of 12 acres of land for one of two existing Semper Augustus bulbs, or a single bulb of the Viceroy which was purchased for a basket of goods (shown at right) worth 2,500 florins.

The increasing mania contributed several amusing, but unlikely, anecdotes that Mackay recounted, such as a sailor who mistook the valuable tulip bulb of a merchant for an onion and grabbed it to eat. The merchant and his family chased the sailor to find him "eating a breakfast whose cost might have regaled a whole ship's crew for a twelvemonth". The sailor was jailed for eating the bulb.

People were purchasing bulbs at higher and higher prices, intending to re-sell them for a profit. However, such a scheme could not last unless someone was ultimately willing to pay such high prices and take possession of the bulbs. In February 1637, tulip traders could no longer find new buyers willing to pay increasingly inflated prices for their bulbs. As this realization set in, the demand for tulips collapsed, and prices plummeted—the speculative bubble burst. Some were left holding contracts to purchase tulips at prices now ten times greater than those on the open market, while others found themselves in possession of bulbs now worth a fraction of the price they had paid. Mackay claims the Dutch devolved into distressed accusations and recriminations against others in the trade.

The panicked tulip speculators sought help from the government of the Netherlands, which responded by declaring that anyone who had bought contracts to purchase bulbs in the future could void their contract by payment of a 10-percent fee. Attempts were made to resolve the situation to the satisfaction of all parties, but these were unsuccessful. The mania finally ended, Mackay says, with individuals stuck with the bulbs they held at the end of the crash—no court would enforce payment of a contract, since judges regarded the debts as contracted through gambling, and thus not enforceable by law.

According to Mackay, lesser tulip manias also occurred in other parts of Europe, although matters never reached the state they had in the Netherlands. He also claimed the aftermath of the tulip price deflation also led to a widespread economic chill throughout the Netherlands for many years afterwards.

Modern views

Mackay's account of inexplicable mania was unchallenged, and mostly unexamined, until the 1980s. However, research into tulip mania in the last twenty years, especially by proponents of the efficient market hypothesis (who are more skeptical of speculative bubbles in general), suggests that his story was incomplete and inaccurate. In her 2007 scholarly analysis Tulipmania, Anne Goldgar argues that the phenomenon was limited to "a fairly small group", and that most accounts from the period "are based on one or two contemporary pieces of propaganda and a prodigious amount of plagiarism". Peter Garber states that the bubble "was no more than a meaningless winter drinking game, played by a plague-ridden population that made use of the vibrant tulip market.

While Mackay's account held that a wide array of society was involved in the tulip trade, Goldgar's study of archived contracts found that even at its peak the trade in tulips was conducted almost exclusively by merchants and skilled craftsmen who were wealthy, but not members of the nobility. Any economic fallout from the bubble was very limited. Goldgar, who identified many prominent buyers and sellers in the market, found fewer than half a dozen who experienced financial troubles in the time period, and even of these cases it is not clear that tulips were to blame. This is not altogether surprising. Although prices had risen, money had not exchanged hands between buyers and sellers. Thus profits were never realized for sellers; unless sellers had made other purchases on credit in expectation of the profits, the collapse in prices did not cause anyone to lose money.

Rational explanations

There is no dispute that prices for tulip bulb contracts rose and then fell in 1636–37, but even a dramatic rise and fall in prices does not necessarily mean that an economic or speculative bubble developed and then burst. For tulip mania to have qualified as an economic bubble, the price of tulip bulbs would need to have become unhinged from the intrinsic value of the bulbs. Modern economists have put forward several possible reasons for why the rise and fall in prices may not have constituted a bubble.

The increases of the 1630s corresponded with a lull in the Thirty Years' War. Hence market prices (at least initially) were responding rationally to a rise in demand. However, the fall in prices was faster and more dramatic than the rise. Data on sales largely disappeared after the February 1637 collapse in prices, but a few other data points on bulb prices after tulip mania show that bulbs continued to lose value for decades thereafter.

Volatility in flower prices

Garber compared the available price data on tulips to hyacinth prices at the beginning of the 19th century—when the hyacinth replaced the tulip as the fashionable flower—and found a similar pattern. When hyacinths were introduced florists strove with one another to grow beautiful hyacinth flowers, as demand was strong. However, as people became more accustomed to hyacinths the prices began to fall. The most expensive bulbs fell to 1–2 percent of their peak value within 30 years. Garber also notes that, "a small quantity of prototype lily bulbs recently was sold for 1 million guilders ($480,000 at 1987 exchange rates)", demonstrating that even today flowers can command extremely high prices. Additionally, because the rise in prices occurred after bulbs were planted for the year, growers would not have had an opportunity to increase production in response to price.

Legal changes

UCLA economics professor Earl A. Thompson argues in a 2007 paper that Garber's explanation cannot account for the extremely swift drop in tulip bulb contract prices. The annualized rate of price decline was 99.999%, instead of the average 40% for other flowers. He provides another explanation for Dutch tulip mania. The Dutch parliament was considering a decree (originally sponsored by Dutch tulip investors who had lost money because of a German setback in the Thirty Years' War) that changed the way tulip contracts functioned:

Before this parliamentary decree, the purchaser of a tulip contract—known in modern finance as a futures contract—was legally obliged to buy the bulbs. The decree changed the nature of these contracts, so that if the current market price fell, the purchaser could opt to pay a penalty and forgo receipt of the bulb, rather than pay the full contracted price. This change in law meant that, in modern terminology, the futures contracts had been transformed into options contracts. This proposal began to be debated in the fall of 1636, and if it became clear to investors that the decree was likely to be enacted, prices probably would have risen.

This decree allowed someone who purchased a contract to void the contract with a payment of only 3 1/2 percent of the contract price (or about 1/30th the contract). Thus, investors bought increasingly expensive contracts. A speculator could sign a contract to purchase a tulip for 100 guilders. If the price rose above 100 guilders, the speculator would pocket the difference as profit. If the price remained low, the speculator could void the contract for only 3 1/2 guilders. Thus, a contract nominally for 100 guilders, would actually cost an investor no more than 3 1/2 guilders. In early February, as contract prices reached a peak, Dutch authorities stepped in and halted the trading of these contracts.

Thompson states that actual sales of tulip bulbs remained at ordinary levels throughout the period. Thus, Thompson concludes that the "mania" was a rational response to changes in contractual obligations. Using data about the specific payoffs present in the futures and option contracts, Thompson argues that tulip bulb contract prices hewed closely to what a rational economic model would dictate, "Tulip contract prices before, during, and after the 'tulipmania' appear to provide a remarkable illustration of 'market efficiency'.

Critiques

Other economists believe that these elements cannot completely explain the dramatic rise and fall in prices. Garber's theory has also been challenged for failing to explain a similar dramatic rise and fall in prices for regular tulip bulb contracts. Some economists also point to other factors associated with speculative bubbles, such as a loosening of monetary policy (an increase in the supply of money), as demonstrated by factors such as a surge in deposits at the Bank of Amsterdam during the tulip mania period.

Social mania and legacy

The popularity of Mackay's tale has continued to this day, with new editions of Extraordinary Popular Delusions appearing regularly, with introductions by writers such as financier Bernard Baruch (1932), financial writers Andrew Tobias (1980), and Michael Lewis (2008), and psychologist David J. Schneider (1993). At least six editions are currently in print.

Goldgar argues that although tulip mania may not have constituted an economic or speculative bubble, it was nonetheless traumatic to the Dutch for other reasons. "Even though the financial crisis affected very few, the shock of tulipmania was considerable. A whole network of values was thrown into doubt. In the 17th century, it was unimaginable to most people that something as common as a flower could be worth so much more money than most people earned in a year. The idea that the prices of flowers that grow only in the summer could fluctuate so wildly in the winter, threw into chaos the very understanding of "value".

Many of the sources telling of the woes of tulip mania, such as the anti-speculative pamphlets which were later reported by Beckmann and Mackay, have been cited as evidence of the extent of the economic damage. These pamphlets, however, were not written by victims of a bubble, but were primarily religiously motivated. The upheaval was viewed as a perversion of the moral order—proof that "concentration on the earthly, rather than the heavenly flower could have dire consequences". Thus, it is possible that a relatively minor economic event took on a life of its own as a morality tale. Nearly a century later, during the crash of the Mississippi Company and the South Sea Company in about 1720, tulip mania appeared in satires of these manias. When Johann Beckmann first described tulip mania in the 1780s, he compared it to the failing lotteries of the time. In Goldgar's view, even many modern popular works about financial markets, such as Burton Malkiel's A Random Walk Down Wall Street (1973) and John Kenneth Galbraith's A Short History of Financial Euphoria (1990; written soon after the stock market crash of 1987), used the tulip mania as a lesson in morality.

The volatility of the tulip market is also a major plot event in Gregory Maguire's novel, Confessions of an Ugly Stepsister.

Tulip mania again became a popular reference during the dot-com bubble of 1995–2001. Most recently, journalists have compared it to the subprime mortgage crisis. Despite the mania's enduring popularity, Daniel Gross of Slate has said of economists offering efficient market explanations for the mania, that "If they're correct ... then business writers will have to delete Tulipmania from their handy-pack of bubble analogies.

Notes

References

  • P.Cos (1637) – Verzameling van een meenigte tulipaanen, naar het leven geteekend met hunne naamen, en swaarte der bollen, zoo als die publicq verkogt zijn, te Haarlem in den jaare A. 1637, door P. Cos, bloemist te Haarlem. – Haarlem : [s.n.], 1637. – 75 pl. available online at Wageningen Tulip Portal Retrieved on August 11, 2008.
  • . Retrieved on June 24, 2008.
  • , JSTOR: 1942889 (subscription required). Retrieved on August 15, 2008.
  • . Retrieved on August 15, 2008.
  • . Retrieved on August 15, 2008.

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