Speculation, it has been noted, comes when popular imagination settles on something seemingly new in the field of commerce or finance. The tulip, beautiful and varied in its colors, was one of the first things so to serve.

—John Kenneth Galbraith

During the 1630s in the Netherlands, a series of events occurred that have been popularized as one of the first recorded financial bubbles. Tulip bulbs escalated in price to the point that particularly rare bulbs traded for sums equivalent to several decades of an average salary.¹ More concerning than this rapid rise in the prices of rare bulbs, however, was a similarly rapid—albeit less dramatic—rise in the price of common tulip bulbs for which there were no meaningful supply constraints. Between November 1636 and January 1637, many tulip prices rose by a factor of 10.

After providing a basic overview of tulips and what made them particularly unique in seventeenth-century Holland, the chapter discusses the social, political, and economic context of the times. Finally, the chapter evaluates Tulipomania via the microeconomic, macroeconomic, psychological, political, and biological lenses—illustrating how the multilens approach presented in Part I can be used to evaluate the likelihood of financial bubbles forming and bursting.

The Uniqueness of Tulips

The tulip is not native to Western Europe. The first noteworthy shipment of tulips from the eastern Mediterranean (where they had been growing in the wild) to western Europe arrived in 1562 on a ship that had arrived in Antwerp from Constantinople.² A year later, in 1563, tulips were brought to Holland by a botanist.³ Cultivation of tulips is believed to have begun in earnest in 1593 when Flemish botanist Charles de l'Ecluse accepted a position at the University of Leiden to establish the Hortus Academicus.⁴

Tulips grow from bulbs but can reproduce by either seeds in the flower or buds that form on the mother bulb. If handled with the appropriate care, buds can directly produce another bulb. After a flower blooms, usually for a week or two in April or May, the original mother bulb disappears. In its place will be the primary bud, in the form of a functioning bulb. Other buds may also be on this new bulb. It is estimated that bulb-based reproduction is able to generate a replacement rate of between 100–150%, implying that meaningful supply growth is severely constrained. Reproduction via seed is a longer and slower process, but one likely to produce greater volume given the high seed count per flower. Seed-based reproduction takes 7–12 years to produce a bulb.⁵

According to Michael Dash, author of Tulipomania, one of the most thorough histories written of the bubble and its context,

It is impossible to comprehend the tulip mania without understanding just how different tulips were from every other flower known to horticulturalists in the 17^th century … . The colors they exhibited were more intense and more concentrated than those of ordinary plants …⁶

The vivid colors, unique patterns, and unusual flames on the petals of a tulip are generated when a mosaic virus “breaks” the flower. This is an important fact because the virus (and corresponding flower coloration and design pattern) is only reproduced via bud-based reproduction. Seed-based reproduction does not reproduce the virus, and hence results in bulbs that may or may not later be broken into a pattern and color scheme that may or may not be deemed desirable. The virus also impacts the bulb's health. Although it may improve the visual appeal of the flower, the virus adversely affects the bulb's ability to reproduce.⁷

As the popularity of the tulips began to rise, they were classified into four primary categories, based on their coloration:⁸

• Colouren—Solid red, yellow, or white
• Rosen—Red or pink on a white background
• Violetten—Purple or lilac on a white background
• Bizarden—Red, brown, or purple on a yellow background

Further, many tulips were given grandiose names, often prefixed with Admirael or Generael. The most famous and sought-after variety was known as Semper Augustus.

Because of the tulip bulb's need to be in the ground for much of the year, physical tulip bulbs could only be uprooted and exchanged between May and September. To accommodate the need for speculators to trade these bulbs throughout the year, contracts were developed and notarized for purchasers to commit to buying (and sellers to commit to selling) bulbs at an arranged price at the end of the growing season. Because these futures contracts did not require full payment, they effectively enabled purchasers to obtain economic and financial exposure to tulip prices with leverage. According to bubbleologist Don Rapp,

Many sales were made on contracts in which the buyers put up little cash, but paid a down payment in kind, with personal goods, and promised to pay the seller a large cash payment after the buyer took possession (based on the expectation that he could sell the bulbs to another buyer at a higher price) … . Thus, buyers were highly leveraged.⁹

Until 1630 or so, most bulbs were sold by the pound. By the 1630s, the rapid price escalation was drawing the attention of financial investors, and the bulbs became desirable not only for their rare beauty, but for their ability to increase in value and be sold for a profit. By offering the prospect of rapid riches, the tulips became an excellent mechanism through which to speculate. As noted by British journalist Charles Mackay in 1841,

It was deemed a proof of bad taste in any man of fortune to be without a collection of them … . The rage for possessing them soon caught the middle classes of society, and merchants and shopkeepers, even of moderate means, began to vie with each other in the rarity of these flowers and the preposterous prices paid for them.¹⁰

Although data is quite limited on the actual trading activity in the bulbs, several of the recorded transactions are noteworthy. In 1633, three rare bulbs were purchased for the equivalent of a farmhouse. The frenetic pace of trading escalated for approximately four years more, when, possibly representing the peak, a rare Violetten Admirael van Enkhuizen bulb sold for 5,200 guilders, an all-time record. A bill of sale from one transaction indicated that one Viceroy bulb was exchanged for “two lasts of wheat, two lasts of rye, four fat oxen, eight fat swine, twelve fat sheep, two hogsheads wine, four tuns beer, two tons butter, one thousand pounds cheese, one bed (complete), one suit clothes, and one silver cup.”¹¹ Quite the exchange for a single tulip bulb! During the 1636–1637 period, some bulbs were changing hands 10 times a day.

Eventually, the bubble burst “at a routine bulb auction, when, for the first time, the greater fool refused to show up and pay. Within days, panic spread across the country. Despite the efforts of traders to prop up demand, the market for tulips evaporated. Flowers that had commanded 5,000 guilders a few weeks before now fetched one-hundredth that amount.”¹²

Fertile Soil for Bubble Formation

The 1630s were an extremely unique time in Holland. The country was embarking on its own golden age of peace and prosperity, having just won itself independence from Spain. Much of the effort and many of the resources that had been channeled into the military struggle for independence were now being productively deployed for commercial and economic purposes. The lucrative East Indies trade was dominated by Amsterdam, where it was thought that per-voyage profits of 400% were not uncommon. According to economist Peter Garber,

From 1620 to 1645, the Dutch established near monopolies on trade with the East Indies and Japan, conquered most of Brazil, took possession of the Dutch Caribbean islands, and founded New York … . Spain ceased to be the dominating power in Europe, and the Netherlands, though small in population and resources, became a major power center because of its complete control over international trade and international finance. The Dutch were to seventeenth century trade and finance as the British were to nineteenth century trade and finance … . At the time of the tulip speculation, the Netherlands was a highly commercialized country with well-developed and innovative financial markets and a large population of sophisticated traders.¹³

To celebrate this new era of prosperity, grand estates were erected across Amsterdam, most of which were surrounded by flower gardens. According to Mark Frankel, in his review of Tulipomania, “the Dutch population seemed torn by two contradictory impulses: a horror of living beyond one's means and the love of a long shot.”¹⁴

This bifurcated approach to thinking of prosperity was a direct result of the unprecedented commercial success the country had experienced following its war with Spain, as well as its recent experience with the bubonic plague. From 1635 to 1637, contemporaneous with the formation of the tulip bubble, the Netherlands was ravaged by the plague.¹⁵ Although data from the period is not complete, the following data points illustrate the magnitude of the problem:

• Almost 18,000 people (more than one-seventh of the population) were killed in Amsterdam in 1636.
• More than 14,500 people died in Leiden (more than a third of the last available population estimate from 1622).
• Between August 1636 and November 1636, more than 14% of Haarlem died from the plague.

This context of tremendously good times (and corresponding financial innovations) with an ominous overlay of disease, uncertainty, and death proved a potent mixture for speculative desire among the Dutch. Mackay captures the spirit of speculation in the air, highlighting the social mood on both the boom and subsequent bust phases of Tulipomania:

The demand for tulips of a rare species increased so much in the year 1636 that regular marts for their sale were established on the Stock Exchange of Amsterdam, in Rotterdam, Harlaem, Leyden, Alkmar, Hoorn, and other towns … . Many individuals were suddenly rich … . Every one imagined that the passion for tulips would last forever, and that the wealthy from every part of the world would send to Holland, and pay whatever prices were asked of them … . Nobles, citizens, farmers, mechanics, seamen, footmen, mid-servants, even chimney-sweeps and old clotheswomen, dabbled in tulips. People of all grades converted their property into cash and invested it in flowers …

At last, however, the more prudent began to see that his folly could not last forever. Rich people no longer bought the flowers to keep them in their gardens, but to sell them again at cent per cent profit. It was seen that somebody must lose fearfully in the end. As this conviction spread, prices fell, and never rose again. Confidence was destroyed, and a universal panic seized upon the dealers … . Defaulters were announced day after day in all the towns of Holland. Hundreds who, a few months previously had begun to doubt that there was such a thing as poverty in the land suddenly found themselves the possessor of a few bulbs, which nobody would buy, even though they offered them for one-quarter of the sums they had paid for them … . Many who, for a brief season, had emerged from the humbler walks of life, were cast back into their original obscurity. Substantial merchants were reduced almost to beggary, and many a representative of a noble line saw the fortunes of his house ruined beyond redemption.¹⁶

There are lots of theorized reasons for the bust phase of Tulipomania, ranging from regulatory intervention to a simple exhaustion of “greater fools.” Professor Earl Thompson at the University of California has suggested that the primary reason for the boom and subsequent bust was due to regulatory changes that effectively converted futures contracts into option contracts and thereby created asymmetric reward for limited risk.¹⁷

To understand why such a change might have a dramatic difference in the price purchasers might be willing to pay, it is best to think of tulip futures as actually paying full price today for a tulip bulb to be delivered in the future. At the time of delivery, the owner of the future contract will be entitled to the gain or loss from their original purchase price. For instance, if I agree to buy a Semper Augustus bulb from you today at a price of $25,000 for delivery in nine months, I effectively own the bulb today at that price. If the price of the bulb goes up, I do not have to pay more, and the gains are mine to keep. Likewise, if the price falls, I suffer the losses of having paid the higher price. I have indeed bought the bulb (to be delivered in the future) for $25,000 and am subject to both the gains and losses that emanate from price movements.

If, instead, I choose to purchase an option contract on the bulb with a price of $25,000, then I have acquired the right—but not the obligation—to purchase the bulb in the future. If the price is above $25,000, I am likely to purchase the bulb. If however, the price falls, then I can simply walk away from the deal and forfeit the money I paid to acquire the option. Given that options offer disproportionate (in theory, unlimited) gain with limited loss potential (your maximum loss is the price you paid to get the option), it is easy to understand why—particularly in a rapidly rising price environment—options might prove a more attractive manner through which to speculate.

Thompson argues that regulatory changes that effectively converted futures contracts into option contracts in November 1636 account for the massive upward surge, while the February 1637 revision to this change accounts for the bust: “The contract price of tulips in early February 1637 reached a level that was about 20 times higher than in both early November 1636 and early May 1637 … and it was simply a period during which the prices in futures contracts had been legally, albeit temporarily, converted into options exercise prices.”¹⁸

The Boombustology of Tulipomania

Having briefly described Tulipomania, we now turn to evaluating the events of the time through the five primary lenses presented in Part I of the book. Each lens considers relevant facets of Tulipomania. The objective of this section is to paint a multidisciplinary picture of the boom and bust sequence that characterized this bubble.

The Multilens Look

The purpose of this chapter was not to be exhaustive in its treatment of Tulipomania or any facet of the period. Rather, it was to demonstrate the power of a multidisciplinary framework through which to analyze bubbles. A summary of the Tulipomania discussion is listed in Table 6.3. The next chapter will similarly illustrate the power of the five-lens framework during the Great Depression.