How Tulips Became More Expensive Than a Villa: Economic Bubbles
Among other firsts in the world, the Dutch gave the economy it’s first ever economic bubble for a flower bulb or more famously known as 'tulip-mania', where cost of a single bulb of Tulip was more than 10 times the annual income of a skilled craftsworker.
In 17th century, Netherlands witnessed the Dutch Golden Age where the Dutch trade, science, military and art were among the most acclaimed in the world. The Eight Years War with Spain marked the beginning of the period. During this time, Dutch East India Company or VOC was founded that was the first ever multinational corporation which was financed by the shares of first modern stock exchange establishment. Among other things, the obsession over tulips was the one that eerily affected the Dutch economy.
What is an Economic Bubble?
According to Investopedia, “a bubble is an economic cycle that is characterized by the rapid escalation of market value, particularly in the price of assets. This fast inflation is followed by a quick decrease in value, or a contraction, that is sometimes referred to as a "crash" or a "bubble burst."
Say, you bought a 50rs. Pen and then sold it to someone for 100rs. Then, you told your friends about the profit earned on the pen. The next day, your friends bought the a bunch of pens at 50rs. each and sold it at 200rs. each. After this, more and more people came to buy the pen hearing of all this profit being made. Each person that joins the rat race, bets they will be able to sell at a higher price to the next person. But eventually you run out the buyers and the price go down. It crashes. This is an economic bubble. The crash is when the bubble bursts.
Why Tulips?
The tulip originated in Turkey but diffused into Western Europe only in the middle of the 16th century, with other vegetables like potatoes, peppers and tomatoes. Their popularity and cultivation in Netherlands is said to begin when a botanist established the Hortus Bontanicus, Netherland’s oldest botanical garden, where he had planted his collection of tulip bulbs for his scientific research purposes. Neighbours then stole the bulbs and began selling them. The tulip was immediately accepted by the wealthy as a beautiful and rare flower, appropriate for the most stylish gardens. The wealthy began to collect some of the rarer varieties as a luxury good.
The flower was considered exotic because it was shipped from the East. To grow a single tulip, it can take years to bloom. The market was for durable bulbs, not flowers. As in so many other markets, the Dutch dominated that for tulips, initiating the development of methods to create new flower varieties. The bulbs that commanded high prices produced unique, beautifully patterned flowers. Apart from this, a virus emerged that made select flowers even more beautiful by lining petals with multicolour flame-like streaks. Unlike such unique flowers, common tulips were sold at much lower prices.
How did the bubble burst?
By 1623, the price of a single tulip bulb was worth 1000 florins (or the Dutch guilders) and by the end of 1625, the same tulip costed 3000 florins, which was more than 10 times the annual income of a skilled craftsworker.
However, for the traders price was never an issue. The more the merrier. But what became an issue was the time tulips take to bloom, which is years. Due to this, a trader couldn’t know what a tulip would look like (which decided the price of the tulip). So while traders wanted to sell these tulips more often, they were held back. These traders then came up with “future contract”. These contracts were a legal document that mentioned an agreement on the selling of tulips at a predetermined price at a specific time in future when the flower blooms. This guaranteed the seller a lower risk by selling the tulip at a lower price and for the buyer it meant lower price but extra risk.
Now these traders were the ones who knew about tulips. But with the scope of the surging profits that many people believed they could make, those who knew nothing entered the market. Because of this, the tulip traded shifted from quality to quantity. The prices kept increasing and it skyrocketed in 1636, only a few months before the collapse of the prices. Tulips sold more and the price was increased ten-fold and the cheaper tulip were sold at twenty-fold price.
The supply of the tulips was excessive in the market. But soon, people started to bid for the tulips at a lower price. This was the point where traders realise that the drop in the market price has arrived. They wanted to sell their tulips before it dropped any further. But once some traders started selling their tulips, the price went down because there were more tulips being sold so in order to compete with other traders, they lowered their price even more but as the prices get lower, more traders sold their tulips. Some traders went to other cities to sell their tulips before the price dropped. And within four days, the bubble had burst across the Dutch Republic.