🌷 Was Tulipmania the Madness of Crowds?

The Seventeenth century was the golden age
for the Netherlands. Trade, industry, science, and art were all
blooming. Some of the reasons for this development were
immigration of qualified employees to the country, its location at the intersection
of East-West and North-South trade routes, cheap energy from windmills, from peat flowing
to cities through canals, and the invention of the sawmill that enabled the Netherlands
to create its commercial and war fleets. At the time Amsterdam was one of the richest
cities in the world, if not the richest. It was both the financial center and main
trade center of the world. A stock exchange was established there in
1602, and though it was not the first one in history, it was, however, as a French historian
Fernand Braudel wrote, the first stock exchange with such high turnover, liquidity, and freedom
of speculation in transactions. This is why some people call it the first
modern stock exchange. It was created in connection to the formation
of large trade companies, such as the Dutch East India Company which is considered to
be the first international corporation and the first company to issue shares and securities. It is also considered the largest and the
most valuable corporation in history. These big companies, however, drew their strength
from monopolistic privileges granted to them by the authorities, one example being exclusiveness
of trade with the lands these companies reached. The Bank of Amsterdam was founded in 1609. Let us return to this topic in a moment. Industry in the Netherlands was also booming,
and its shipyards and sugar factories blossomed. Agricultural production increased as well. In the seventeenth century the Netherlands
one’s social status gradually became more and more determined by income than by birth,
making merchants the dominant class in society and allowing them, as it were, to buy into
the upper classes. The society’s wealth grew. A well-known flower, the tulip, became one
of the symbols of high status. Tulips came to Europe from Turkey. Initially, they appeared in Vienna, and then
in the Netherlands. In Europe tulips were considered exotic plants
at that time. Their colors were much more intense than those
of other flowers known then to Europeans. And so tulips quickly became a very desirable
luxury good. They were separated into different categories
according to colors: from ordinary one-colored to multicolor varieties, like tulips with
white stripes on red or lilac petals. Let us note that broken colors of multicolored
tulips was caused by an infection with a virus called tulip mosaic virus or tulip breaking
virus. We know it now. The symptoms were known in the seventeenth
century, but nobody linked the effect to the virus, and the infected flowers were considered
beautiful. Nevertheless, the virus caused weakening and
slower growth of plants as well as impaired development of bulbs. The virus spread only through the tulip’s
bulbs and not through its seeds, so infected bulbs were particularly sought-after on the
market for this particular effect. But as a result of the disease the supply
of such bulbs was reduced, thus increasing their prices. Their breeders assigned to these rare varieties
various names such as Semper Augustus, Admiral Van der Eyck, or Viceroy. In 1634, speculators entered the tulip market,
attracted by high demand for bulbs in France. From that moment people bought the bulbs not
only to plant them in gardens, but also to profit from their rising prices. Prices continued to rise until they reached
levels that at first glance may seem absurd to us. Thus began tulipmania. The story of the mania was popularized by
Charles Mackay in his book Memoirs of Extraordinary Popular Delusions and the Madness of Crowds,
first published in 1841. He describes it as follows: “The tulip-jobbers speculated in the rise
and fall of the tulip stocks, and made large profits by buying when prices fell, and selling
out when they rose. Many individuals grew suddenly rich. A golden bait hung temptingly out before the
people, and, one after the other, they rushed to the tulip marts, like flies around a honey-pot. Every one imagined that the passion for tulips
would last for ever, and that the wealthy from every part of the world would send to
Holland, and pay whatever prices were asked for them. The riches of Europe would be concentrated
on the shores of the Zuyder Zee, and poverty banished from the favoured clime of Holland. Nobles, citizens, farmers, mechanics, seamen,
footmen, maidservants, even chimney-sweeps and old clotheswomen, dabbled in tulips. People of all grades converted their property
into cash, and invested it in flowers. Houses and lands were offered for sale at
ruinously low prices, or assigned in payment of bargains made at the tulip-mart. Foreigners became smitten with the same frenzy,
and money poured into Holland from all directions. The prices of the necessaries of life rose
again by degrees: houses and lands, horses and carriages, and luxuries of every sort,
rose in value with them, and for some months Holland seemed the very antechamber of Plutus.” Mackay also writes that two last of wheat,
four lasts of rye, four fat oxen, eight fat swine, twelve fat sheep, two hogsheads of
wine, four tuns of beer, two tons of butter, one thousand pounds of cheese, a complete
bed, a suit of clothes, and a silver drinking cup were delivered for a single root of the
rare Viceroy variety. The total value of the transaction was 2,500
florins. By comparison, the average wage of a skilled
worker at the time amounted to 150 florins a year. According to Mackay it was not the most valuable
tulip at all. Semper Augustus variety was considered very
cheap at 5,500 florins; once a person even offered twelve acres of building ground for
it. To understand the specificity of the bulb
trade, we must briefly talk about their cultivation. Tulips bloom in April and May. To avoid destroying the plants, the bulbs
have to be removed from the ground not sooner than in June, but must be replanted in September. This is why trading in bulbs can only take
place from June to September. In all other months all exchanges have to
be conducted as futures contracts. Because of that clients only buy a promise
of having bulbs delivered after their harvest is possible. As American economist Peter Garber writes
in his article Tulipmania, thus in the seventeenth century Netherlands formal futures markets
developed, and were organized in taverns and took place in groups called “colleges.” The buyers were required to pay a small percentage
of the contracted amount, and no margin nor margin deposits to guarantee compliance were
required. Typically, the buyer did not currently possess
the cash to be delivered on the settlement date and the seller did not currently possess
the bulb, so only a payment of the difference between the contract and settlement price
was expected. The contracts themselves were also traded
and some accounts indicate that a single contract could change hands several times a day. The speculative mania reached its peak between
1636 and 1637. It encompassed not only prices of bulbs of
rare tulips, but near its end also prices of common tulips. The prices skyrocketed, as in case of the
Witte Croonen variety. Its price multiplied by a factor of 26, and
then after the bubble burst it dropped to 1/20 of its peak in February 1637. And February 1637 is precisely when the tulip
bubble burst. It started in the city of Haarlem, where for
the first time none of the clients appeared at the auction. Some explain this disappearance with the plague
that afflicted the Netherlands at the time. The bubble burst in the winter when bulbs
were safely underground, so the problem was what to do with the futures contracts. According to American economist Earl Thompson,
a large organization of Dutch florists and planters announced in a decision later ratified
by the parliament that the buyers of all contracts made between November 30, 1636 and the reopening
of the cash market in Spring were relieved of their unconditional obligations to buy
the future tulips at the specified contract price, although they had to compensate the
planters with a small percentage of their contract prices. Mackay describes the bursting of the bubble
as follows: “At last, however, the more prudent began
to see that this folly could not last for ever. Rich people no longer bought the flowers to
keep them in their gardens, but to sell them again at cent per cent profit. It was seen that somebody must lose fearfully
in the end. As this conviction spread, prices fell, and
never rose again. Confidence was destroyed, and a universal
panic seized upon the dealers. […] Defaulters were announced day after
day in all the towns of Holland. Hundreds who, a few months previously, had
begun to doubt that there was such a thing as poverty in the land, suddenly found themselves
the possessors of a few bulbs, which nobody would buy, even though they offered them at
one quarter of the sums they had paid for them. The cry of distress resounded everywhere,
and each man accused his neighbour. The few who had contrived to enrich themselves
hid their wealth from the knowledge of their fellow citizens, and invested it in the English
or other funds. Many who, for a brief season, had emerged
from the humbler walks of life, were cast back into their original obscurity. Substantial merchants were reduced almost
to beggary, and many a representative of a noble line saw the fortunes of his house ruined
beyond redemption.” Mackay’s story, although still popular and
often quoted in discussions of the tulipmania, is not really respected by economists and
historians. It is based mainly on religiously motivated
pamphlets against speculation that tell a story about evils of dealing with material
matters instead of focusing on spiritual ones. Scientific credibility of such sources is
low, because they most probably exaggerate their depictions of the events. Economists call into question both the scale
of speculation, and the extent of consequences of the bubble bursting. Some even deny the very existence of the speculative
mania. They admit that the tulip bulbs actually reached
prices that seem gargantuan to us, and that thereafter the prices fell sharply, but these
critics claim that even then the prices were in tune with the fundamentals. The analysis of the issue presents a challenge,
as the data is rather inaccessible, incomplete and incomparable. But in spite of that, several potential scientific
explanations of the phenomenon exist and together they form a certain story. Needless to say, the discussion between economists
is, as usual, far from conclusion. Prepare yourself though, as that these explanations
are somewhat intricate. One such economist, Peter Garber, argues that
mania is an inadequate term for the tulip market at the beginning of the seventeenth
century. In Tulipmania he compares prices of new varieties
of tulips with historically later prices of new varieties of hyacinths, and then he analyzes
their price declines in the long run. What Garber finds is that on the flower market
extremely high initial prices of rare varieties of flowers are not really such an anomaly. He also finds that there is nothing strange
about prices falling to a fraction of their initial value. In addition, Garber compares the long-term
decline in prices during the tulipmania with similar phenomena in later periods, which
are not considered manias nor bubbles. He notes that the annual rates at which prices
declined are similar in all cases and amount to around 40%. He finds that even in modern history the prices
of new prototype varieties can reach amazing prices. One of his examples is a new variety of lilies. A small quantity of its bulbs were sold for
the equivalent of $480,000 at 1987 exchange rates of guilder, apparently proving that
very high prices for rare plants are not necessarily a sign of the “madness of crowds.” He concludes that most of the 1634 to 1637
period was nothing like such a madness. He admits, however, that his study does not
explain the huge increase in prices of ordinary common bulbs in the last month of speculation
and concludes that it may signify a potential bubble. Another economist who tackled the topic is
Earl Thompson with his article The Tulipmania: Fact or Artifact? He uses a more complete data set of the period
in order to refute Garber’s conclusions. Thompson finds that although in the long run
the annual price drop could amount to around 40%, in the three months after the peak of
the bubble, prices fell more sharply and more violently. According to Thompson, prices declined by
as much as 99.999%. Thompson disagrees with Garber as for the
causes of the situation. As mentioned, the buyers of all futures contracts
made between November 30, 1636 and the reopening of the cash market in spring could pay only
a small percentage of the contracted price in order to back away from buying the tulips
at contracted price. Thompson writes that in effect this decision
basically converted the futures into options contracts. The difference is that in case of futures
contracts buyers have an obligation to purchase at specified contract price, and in case of
options the obligation disappears leaving buyers with the right to either buy at specified
contract price, or resign and incur only relatively small fees. Thompson further explains that this legislation
was publicly discussed much earlier. His wider examination of the entire tulip
boom period reveals that after 1634 both prices and the number of tulip trade participants
were rising until in October 1636 the prices suddenly declined in the first crash. Thompson argues that the collapse was caused
by the news of the Battle of Wittstock, where at the start of October 1636 Germans were
suddenly defeated by the French. German princes eagerly bought tulips to decorate
their summer estates, and threats from the French as well as from domestic rebels could
hamper their demand. Many people, including state officials, lost
a lot of money during the decline. According to Thompson the debates about market
futures that started in the aftermath led market participants to expect with a high
degree of certainty that all futures contracts made after the October collapse would be legally
changed into options. These expectations caused the sudden rise
in prices. People figured that they will profit in case
of spot price exceeding contracted price, and in the opposite scenario they will simply
refuse to buy bulbs; this expectation caused the prices to skyrocket. Thompson points out that well informed speculators,
officials and breeders could make up for losses by setting a different date of conversion
of contracts than what was previously announced: “Settling on a November 30th rather than
an October termination date for the original contracts heavily favored, besides the planters,
those speculators who sold contracts in late November to individuals who held the common
expectation that contracts written in November would be options rather than futures contracts. The negotiating public officials, being much
more informed than the public, could therefore more than offset their losses on their earlier
purchases by selling contracts in late November, when, based on the previous announcements
of the trusted public officials, the buyers had already begun treating the contract prices
as option strike prices set at around 10 times the actual prices […].”
Thompson concludes that the entire speculative mania in December 1636 and in January 1637
was already carried out based on the expectation that it would be possible to simply abandon
the purchase of bulbs. He further indicates that in this period the
prices of the actual futures contracts that were to end in actual sales already decreased
substantially. The humongous prices of exercising options
between December and the crash were never realized. The real victims of the whole situation with
conversion were November buyers who thought falsely that they will not have to pay the
contracted price. American economist Douglas French takes another
stance in his book Early Speculative Bubbles and Increases in the Supply of Money. French studies the impact of monetary factors
on the speculative bubble, focusing in particular on significant rise in money supply. The starting point in his analysis is the
introduction of free coinage laws in the late sixteenth century Netherlands. Free coinage meant that the state will mint
coins out of any quantity of metal delivered to it. The provider of the metal was to receive the
minted coin free of charge or for a very small fee. The law attracted gold owners who tried to
avoid high minting fees charged by other rulers. The trade in Amsterdam was carried out mainly
with foreign coins, and the local ones were used only to a small extent. Introduction of new coins into circulation
was difficult at the time, because according to Gresham-Copernicus law “bad money drives
out good”, and foreign coins were often of poor quality. To remedy this, the Bank of Amsterdam was
originated in 1609. The Bank accepted the coins as deposits based
not on the face value of the coins, but on the metal weight or intrinsic value of the
coins. In turn, depositors received banknotes that
were convenient in use. A single currency was thus created. The City of Amsterdam guaranteed the security
of deposits, and the Bank of Amsterdam did not grant loans at that time, and as such
operated as a full-reserve bank. Because of the convenience and the security,
people deposited their coin eagerly, and the bank money was even traded at a premium over
coins. The free coinage laws combined with the stability
of the Bank of Amsterdam, as well as increased trade and treasures confiscated in international
waters by the Dutch fleet, caused a huge influx of silver and gold to Amsterdam followed by
an increase in the supply of coins. French calculated that from 1633 to 1638 the
deposits at the Bank grew by 60%. On the basis of Austrian business cycle theory
French argues that this surge in the money supply was the main cause of the speculative
mania. Garber claims that tulipmania could not cause
too much misallocation of resources such as land, because the largest speculation in its
entirety took place when the bulbs were in the ground and it was impossible to plant
more. French points out, however, that the effects
of the bust were significant and noticeable, as that the number of bankruptcies doubled
between 1635 and 1637. French contends that: “The story of Tulipmania is not only about
tulips and their price movements, and certainly studying the ‘fundamentals of the tulip
market’ does not explain the occurrence of this speculative bubble. The price of tulips only served as a manifestation
of the end result of a government policy that expanded the quantity of money and thus fostered
an environment for speculation and malinvestment.” He also admits that the episode differs from
present-day experience: “But what made this situation unique was
that the government policy did not expand the supply of money through fractional-reserve
banking, which is the modern tool. Actually, it was quite the opposite that occurred. As kings throughout Europe debased their currencies,
through clipping, sweating, or by decree, the Dutch provided a sound currency policy
which called for money to be backed 100 percent by specie. This policy, combined with the occasional
seizure of bullion and coin from Spanish ships on the high seas, served to attract coin and
bullion from throughout the world. The end result was a large increase in the
supply of coin and bullion in 1630s Amsterdam. Free coinage laws then served to create more
money from this increased supply of coin and bullion than what the market demanded.” All in all, the three studies form a picture
of the situation that offers some sensible explanations for the causes of the tulip bubble. We can now reject Mackay’s thesis about
the sudden and unjustified collective madness of crowds. Each of the three attempts at explanations
by said economists casts a slightly different light on the story, thus enriching our knowledge. It is only regrettable that we cannot see
with our own eyes the tulips sold in the seventeenth century Netherlands, because most of these
varieties — if not all of them — did not survive to our times.


  1. Great work! Will there be any video on Long Depression? I heard that it is “Free market and laissez-faire capitalism failure” too.

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