This article originally appeared in the TDV May 2021 Issue.
Tulips were first introduced to the Netherlands from Turkey around 1550. The bulbs get their distinctive coloration patterns from being infected with the mosaic virus. These traits then get passed down to the buds which can blossom into new bulbs carrying the same patterns. But not the seeds. The seeds simply grow to become a common flower, which can then be infected by the virus, and create its own pattern.
The highly infected bulbs produced the most coveted patterns, but also took longer to reproduce.
In an economic sense the bulbs could be regarded as a capital good when they were used to produce buds that became commodities for resale. The flower growers ultimately cultivated the market for prize bulbs through celebrity endorsements and advertising the high prices paid by sophisticated buyers, a marketing tactic still used by auction houses in the present day. The initial buyers were indeed sophisticated, for they knew they could recoup their original investment by selling the buds from the tulip over time. In a sense, they were speculators, with their profits dependent on the future market value of the bulb, which depended on the number of bulbs in circulation, the growth rate of the bulb supply, and the fickle taste of the consumers.
Naively, many historians mistook the high prices paid to be signs of a craze, when it was in fact merely a routine business decision much like any other. That is, economic actors were largely acting rationally.
The flowers of the tulip appear in April and May, around now, and are only in bloom for about a week.
The bulbs can be removed from the ground in June, but must be replanted again by September. This characteristic lent the bulbs some monetary attributes. You could carry them in your pocket or in a pot, making it easy to transport them. They still had a history of retaining value, even though their money prices were falling.
Naturally, if the bulb produces two buds a year and prices halve, the owner wouldn’t lose anything. Charles Mackay, in his zest to make market participants appear foolish, never bothered to account for this simple fact, and future historians have followed his example without even trying to understand the market. But sometime in the early 17th century, the monetary attributes of tulips started to gain attention as the Spaniards had flooded Europe with gold and silver they discovered from the new world.
As a consequence, inflation ran high. Between 1606 and 1626, many prices doubled in terms of gold and silver. The people had already seen their fair share of monetary debasement under the reign of Charles V (1506-1555), who routinely altered the gold:silver ratio to pay off his debts cheaply by debasing the coins.
The “revolution” that followed his rule brought free coinage. Gold and silver from all over America and Europe flooded into the Netherlands, to be converted into Dutch Guilders for free or at minimal cost by the state mint. The Bank of Amsterdam was established in 1609 and its notes took the place of gold and silver coins in commerce. Although by law the notes were 100% backed by bullion, the bank’s records were kept secret. We can only speculate about the increase in money supply brought about by these bank notes.
What we do know is that Amsterdam was flooded with gold. Between 1633 and 1638, bank deposits at the Bank of Amsterdam grew by 60%, from five to eight million florins. 1637 also happened to be the year the Tulipmania peaked. Coincidence? I think not. A more reasonable explanation for tulipmania is that the Dutch people fatefully concluded that rare tulip bulbs were a better store of value than gold or the bank’s notes.
Soon after, futures contracts were introduced, bringing in even more liquidity, likely fueled by the bank’s ongoing note inflation. As the monetary inflation accelerated, it drove bulb prices ever higher – ultimately bringing an overproduction of bulbs – until it became a mania. The Dutch government helped the bubble along with edicts that discouraged short selling enacted in 1610 and reinforced with further edicts in 1621 and 1630. But they changed the rules with a piece of retroactive legislation. On February 24, 1937, the Dutch Parliament, acting on behalf of buyers who had lost money on their speculation due to a market decline, nullified all futures contracts written after November 30, 1636 and assigned fixed compensation to the sellers. This effectively destroyed the futures market and marked the end of Tulipmania.
Thus, we see that the bubble in tulips was driven by the same factors as any other modern day bubble, namely an increase in the supply of money (in this case the state mint and Bank of Amsterdam rather than the modern day central bank) and government interference in the market creating winners and losers. Without edicts against short selling, the speculators would have checked against the wild increase in price, stopping the bubble in its tracks. Without the final legislation nullifying futures contracts, contract law would have determined the outcome and the late stage speculators would have got their just desserts. Instead, the market was completely destroyed at the stroke of the legislative pen and prices crashed 99.5%. And they got to blame it on market failure.
Early Speculative Bubbles and Increases in the Supply of Money, Douglas French
Red-Blooded Risk: The Secret History of Wall Street, Aaron Brown