Tulip Mania: A Lesson in Capitalism

Or how we invented the stock market

One of the most important moments in the history of the world was the rise of capitalism in the 17^th century. No land was more consequential for the rise of capitalism than the Netherlands, an economic powerhouse of that time period that created stock exchanges, global economies, the first corporations, and what we will discuss today: the first financial bubble.

We all have heard the basic story of tulip mania. To summarize, in the 1630s, the Dutch had formed a republic for the first time in their history, led by a new middle class that was eager to stretch its economic might and showcase its wealth and prestige. However, the religious laws at the time made sure that there were limits to what could be purchased to show off. As a result, tulips became a symbol of the growing entrepreneurial class, with rarer tulip varieties becoming more valuable.

The reasons for tulips becoming the status symbol of the Dutch were manifold. For starters, as the flowers were native to Central and West Asia, they were (at the time) quite rare in Europe. They involved activity (growing, planting, and trading) to use and were inherently customizable, with many varieties, some rarer than others.

Soon, the prices of valuable tulip varieties, such as the Semper Augustus, reached astronomical levels. In one notable example in February, 1637, a flower sold for 5,000 livres, when a skilled worker’s salary would be 250 livres a year. In other words, the most expensive tulips sold for the price of some of the most expensive Amsterdam homes.

As the tulips market grew more competitive, a futures market emerged for the first time. Individuals purchased the option to purchase tulips in the next harvest season with IOUs, hoping to sell them for a profit in the future. Then, they would sell these options to those hoping to profit on them, creating a second-hand market for tulip options, traded through IOUs.

Interestingly, despite pioneering options trading, the tulip traders were excluded from Amsterdam’s financial markets, as the trading of tulips was considered inferior to the “genuine” trading on the stock market.

Eventually, the tulip market reached a peak in February 1637 when the market began to collapse. Contrary to popular belief and my initial assumptions, the market crash was not the result of increased skepticism in investors, but due to an increase of supply. As it turned out, tulips happened to grow really well in the Netherlands, and soon the tulip market was flooded with an exceptional amount of tulips after a great harvest season.

As the value of tulips fell, many investors were left with IOUs to pay off their IOUs, leaving the entire tulip market on shaky grounds. Eventually, most Dutch courts invalidated most of these IOUs, saving most investors while bankrupting the tulip farmers who initially sold these tulips.

Most storytellers end the tale of tulip mania right here, often with some note about how this was the first financial bubble to ever burst in our economic history. However, after reading up a little for this article, I think that tulip mania is a bit more complicated than pop culture depicts it as.

For one, while the tulip market crashed, it eventually recovered, to the point that tulips are still one the Netherlands’ most profitable exports. In fact, not long after the tulip crash, the struggling tulip farmers found new markets throughout the rest of Europe and the Middle East.

Additionally, the worst effects of the tulip crash were exaggerated by British and Dutch upper class, both of whom would benefit to see the discreditation of their rivals in the emerging Dutch merchant class.

As a student of financial markets, I find many ties between tulip mania and the dot-com bubble of 2000. Both of these crashes were proclaimed to be the end of their respective products from respected academics, but both went on to continue to be successful because people liked the products beyond their investment.

People found value from tulips and websites beyond meaningless financial speculation, and thus these products survived their initial financial crashes. This is what differentiates tulip mania and the dot-com crash from crazes such as beanie babies and pet rocks; there is an underlying value to the product being sold.

Part of me wonders if an initial crash is a required growing pain for any new product that becomes a conduit for investment. It happened with internet, it happened with tulips, and you could argue that it is happening with cryptocurrency, but that is a topic for another day.

In our post-Black Thursday financial world, it is a generally acknowledged truth that infinite growth for a potential market is improbable, if not impossible. However, I’d argue that for any product which people derive use from, infinite loss is also impossible.

Eventually, a market stabilizes. It will no longer generate flashy headlines about gains and losses as it used to, but it will become an acknowledged part of the world. That is what happened to tulips nearly 400 years ago, with websites twenty-five years ago, and will continue to happen into the future.