Tulip Mania in the Dutch Golden Age

It is strange to think that something as beautiful and simple as a flower could have led to the world’s first financial bubble.  In the 1630s, the Netherlands is exactly where this happened.  For several years the prices of tulips had been speculated and driven up to prices that were previously unimaginable.  When this tulip bubble popped, traders, merchants, and craftsmen saw their entire life savings wiped away as the prices of tulips fell at an alarming rate.  The effects of the burst of the tulip bubble had dramatic effects on the Dutch economy and drove the entire country into a mild depression.  In recent years, we saw the burst of the housing bubble which led to millions of Americans losing their home and the eventual fall of Lehman Brothers.  Though centuries apart, there are many similarities between the burst of the 1636 Dutch tulip bubble and the 2007-2009 American housing bubble. 

The 17^th century saw the rise of the “Dutch Golden Age” when the city of Amsterdam was one of the richest of all cities in Western Europe due to its strong international trade.  With the booming economy, Dutch trade with foreign countries led to the importation of many foreign goods that had not been seen before in the Netherlands.  As the importation of exotic goods continued on, Tulips were introduced into the Netherlands and the ability of these flowers to withstand the harsh northern-European climate, along with their unique beauty, made them a status symbol in gardens across the Europe. 

During the spring months, tulips bloomed for about one week, with the bulbs appearing during late summer and early fall, thus confining Dutch sales to that season.  As sales and trades for the tulip bulbs began to rise, a type of derivatives market was formed so buyers and sellers could conduct trades year round.  This rudimentary derivatives market had contracts that were very similar to modern options, forwards, and futures contracts.  Like a modern futures contract, buyers and sellers would come together and decide on an appropriate price for the tulips in the upcoming year, then sign a contract for delivery on a specific date, at a specific price. 

The tulip bulb contracts traded daily amongst the Dutch became an important attribute to the Dutch economy and their prices quickly began to rise as popularity grew.  Craftsmen and merchants were selling everything they owned and gathering their life savings to purchase tulip bulbs because they saw how successful their neighbors were becoming at “flipping” the tulip bulbs.  In a matter of a few years, the prices of these bulbs went from being worth as much as an onion, to being ten times a craftsman’s annual income by the end of 1636. The Dutch Golden Age was at its peak and Tulip Mania was now the driving force behind this thriving economy. 

Winter of 1636, a few defaults on tulip bulb contracts led to a domino effect and the tulip bulb bubble popped as supply exceeded demand.  Sellers were overwhelming the market while buyers suddenly disappeared.  Within a few days, the tulip bulbs were worth a small fraction of what they once were.  Many dealers refused to honor the contracts and looked towards the government for intervention.  The government eventually stepped in and attempted to aid the tulip bulb meltdown by offering 10% of the contracts face value to the dealers.

The popping of the tulip bulb bubble ended the Dutch Golden Era and had lasting effects on the country.  In retrospect, you would think that over the course of Tulip Mania someone would have said, “Look, these bulbs are grossly overvalued and this needs to stop.”  However, through the speculation and large profits, dealers were blind to what was really going on and ended up with catastrophic losses.  Bubbles like this again show their faces throughout history, most recently, with the housing bubble and credit crisis from 2007-09. 

Following the tech bubble and recession of the early 2000s, the Federal Reserve began to lower interest rates in an effort to increase the flow of capital. As money fled the stock market, it began to spread into other sectors of the economy. Real estate was the preference of many investors, because of cheap money (low interest rates) and government intervention that artificially increased the demand for housing. Government sponsored lenders Fannie Mae and Freddie Mac  began to lower their underwriting standards so that Americans who could not previously own a luxurious home, could now borrow money for a home in which they did not have the means to afford.  As lenders became more lenient, demand for homes began to rise, and just as the prices for tulip bulbs rose following the demand in Tulip Mania, the prices of homes rose following the strong demand for housing.

When prices for bulbs in Tulip Mania increased, investors sought to speculate on the prices which further caused the prices to spike.  In a similar manner, during the housing bubble, home prices rose and financial institutions packaged together securities that contained these risky loans and sold them on Wall Street creating a market for the speculation of risky mortgages.  The housing bubble popped in a similar manner as the tulip bulb bubble did when people could no longer afford their risky loans they had taken out.  Investors thought that home prices would keep rising and once they stopped, they attempted to dump their worthless securities on the market and caused mayhem in the financial industry.  The home prices were speculated beyond their value and eventually plunged leading to a recession that lasted until 2009.

Though the assets being exchanged and speculated on in the Tulip Mania and housing bubble were completely different, it is not hard to see that both were driven by speculative frenzies and it only took a few defaults to expose and deflate the bubbles.