Sat 11 Sep 2010
I’ve been trying to understand what a financial bubble really means, and in the course of this, came across some interesting information: apparently the great Dutch Tulip bubble of the 1630s wasn’t a bubble after all. Although I am wary to merely summarise stuff that is written better elsewhere, I thought this was a good one to share.
Tulips came to the Netherlands from Turkey in the 1500s, and became a popular status symbol. Multicoloured varieties were produced due to the effects of a plant-specific virus, and as a result (skipping the details), it would take at least seven years after planting the bulb of a spectacular tulip to produce new tulips from it. Understandably, possessing a spectacular tulip bulb gave you an advantage for quite a period of time before others could gain a similar bulb.
Due to rising prices, speculators entered the tulip market in 1634, and a more formal futures market in bulbs arose in 1636. By some accounts, offers for single bulbs reached insane levels, e.g. 49,000 m^2 of land for a bulb. In February 1637, the price of tulips crashed. For the next few centuries, “tulip mania” is used as a textbook example of crazy market behaviour with a boom and bust.
Why not a bubble?
If a bubble is where markets are caught up in “irrational exuberance”, then it appears that this market continued to be rational. And if a bubble is where a market eventually “pops” and the resulting crash causes widespread losses, then it appears that losses were not significant. Of course, it is hard to know for sure, since all of this happened almost four centuries ago, but there is apparently some evidence that:
- In February 1637, the futures contracts all became options contracts, i.e. the purchaser of a contract to buy bulbs no longer had the obligation to purchase or take delivery of the bulbs if it looked like they would make a loss.
- This change was known to be coming from several months beforehand, encouraging purchasers of contracts to agree to high bulb prices with minimal risk. Taking this perspective, the contracts were rationally priced.
- Actual tulip prices (as opposed to the price of these futures contracts) remained at ordinary levels.
- The Dutch authorities halted the trade in the contracts, and later decreed them unenforceable gambling debts. So, given that no tulips changed hands that winter (as the tulips would’ve all been in the ground) and the contracts were unenforceable, it’s not clear that there were any significant losses made.
- Most of the support for claims of a tulip bubble come from some anti-speculation propaganda published soon afterwards.
Perhaps, then, there was no Tulip bubble. I guess all those textbooks need updating.