Pranav—Understanding the tulip mania
I’ve always been confused by the Tulip Mania. I never knew much about it, but it just seemed absurd. Why were people randomly bidding up the price of flowers to the point of madness?
I thought I’d find myself an answer.
Let’s first set the scene. We’re living in an era where there’s absolutely nothing exciting about agricultural produce. That was not true of the 1600s. The world has just gone through the Columbian exchange, and all sorts of exotic new plants were making their way across the Old World. That was when Emperor Suleiman (possibly?) sent Europe its first tulip bulbs.
Tulips were unlike anything the Europeans had ever seen. It was a stunningly pretty flower, more vibrant than any flower on the continent. It became a coveted luxury item, partly because of how scarce it was. It bloomed for a single week in the year, and hit the markets many months later.
The Dutch, meanwhile, were mastering many early financial innovations. One of them was the forward contract. That is, you could buy something that would be delivered to you at a specific, later date. This was ideal for tulips: given how rare they were, and how short a period they bloomed for, it made sense to arrange for your tulips in advance.
But soon, people clamoured to buy tulips from as far as France. All through Dutch society, people gave up their old occupations and began growing tulips — but the demand never seemed to cease. The price of those forward contracts skyrocketed. And as they rose, people expected them to rise even further. You could purchase a forward contract, and if prices went up further, you could sell it onwards and make a profit. And guess what happens when you hope to trade a financial instrument for a profit? It brings in speculators. Of course.
By the winter of 1636, single contracts were changing hands five times. The whole enterprise depended on the hope that someone out there would buy the contract at an even higher price. For a while, that continued to stay true. But then, prices suddenly collapsed. Trade ground to a halt. The way these contracts worked, nobody paid in an initial margin, and as prices fell, people refused to pay and take delivery of the tulips.
The next two years would be consumed by chaos. There would be court cases, and contradictory decisions by city councils, and plenty of heartburn. Most of those contracts would never be honoured.
The Dutch were pioneers of finance. They took the sort of implicit contractual arrangements that were common everywhere in the world to their logical conclusion. And they learnt, for the first time, that while it helped them spread risk in a way that had never been seen before, it was also the path to madness. This was a lesson that we have learnt many times since — and continue to learn today.
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