“How much would you pay?” was the patent question every Amsterdam merchant would ask during the 1630s. Living in spacious, lavish mansions surrounded by lush flower gardens, the skilled merchants and traders were brimming with wealth. But what mattered to them more than money was the number of tulips that one could spot in their gardens. Before coming straight to tulips, let us go back a little and dig deeper into the story.
The 17th century saw the Netherlands enter the Dutch golden age and by the 1630s, Amsterdam was already a flourishing commercial center. Dutch ships imported spices from Asia in huge quantities to earn profits by selling them to the rest of Europe, while from East Europe (mainly the Ottoman Empire), tulips were imported. Because of this and the fact that it was very difficult to grow them since they take years to bloom, the tulip was considered an exotic flower.
During the 1630s, an outbreak of the tulip breaking virus made the infected flowers even more beautiful. It created breath-taking patterns in tulips by lining petals with multicolor, flame-like streaks. This infected tulip was more scarce than the regular uninfected tulip which was already quite rare in Amsterdam. As an obvious result, the demand for tulips by the affluent merchants of Amsterdam grew manifold. With the rise in demand, the prices increased too along with a growth in the somewhat surprising popularity of tulips. They soon became a status symbol and were used to measure a person’s wealth and worth. This is how the Tulip Mania came into being.
‘Mania’ is the opposite of the Law of Demand. Unlike the former where higher prices lead to a fall in demand, in a mania, with the upward movement of price, people are somehow willing to pay even larger sums of money for a commodity that has a much lower intrinsic value. People even started taking loans and selling other assets to buy a few tulip bulbs. Those who previously did not even know what bulbs were, were signing futures contracts to invest in them, driving the market into a frenzy.
A more recent and better-known example is the dot-com mania of the 1990s or the real estate bubble of the late 2000s. Tulips were like the tech stocks or mortgage-backed securities of the 17th century. Everybody wanted them but only a few had them. The more the demand, the higher the price. Simple economics!
At one point, a single tulip bulb sold for more than ten times the annual salary of a skilled craftsman. Seeing the excessive (and unreasonable) increase in the price of tulips, merchants started importing more of tulips, which further pushed the prices up. This was the groundwork for the development of a Tulip Bubble, a divergence of tulip prices from their fundamental (and much lower) value, characterized initially by a strong upward movement and consequently followed by a rapid decline in prices.
Merchants began ordering and pre-ordering tulips. Seeing the dramatic increase in the demand and eventually the sky-rocketing price, producers increased the harvest. With this eventual increase in supply, there was an added pressure on the price.
All that was needed was the gloomy yet obvious realization that the market price of a tulip was much higher than its worth, which was inevitable. As this realization dawned upon the people, the hype over the exotic flower subsided, and its demand suddenly ceased to exist. With the newly low demand and the already high supply, the prices fell to an all-time low, as low as 10% of its peak value within six weeks.
What next? The bubble burst, the market crashed and the mania ended. With the excessive supply, everyone wanted to sell bulbs but there was no one to buy them. The merchants and the people who owned tulips or even their bulbs suffered huge losses. Dutch courts rendered the contracts on the sale of Tulipa voidable, if payment of 3.5% of the price was paid, as the only, and somewhat minor, relief to the sellers.
However, Earl Thompson, in his paper published in 2007, says that since the market followed the normal conditions of demand, supply, and market equilibrium, the market was actually efficient. But he argues that there is still a question of “rational expectations on the part of the buyers” since the excessive optimism would just have led to the increase in the number of contracts without affecting the prices substantially. This further proves that there can be “inefficient over-optimism” in the tulip market which made the overall efficient market inefficient to some extent.
Even today, scholars work hard to find the reasons for and solutions to a Bubble and a Mania. Tulipmania is useful to understand the fact that the economy will go through thick and thin and booms and bursts. For all of us, let us be grateful that we do not have to spend an arm and a leg or in other words, sell our kidneys to buy Tulip and Tulip bulbs.