Category: Tulip and bubble craze

The 1990s was a period of rapid technological advancement in many areas. But it was the commercialization of the Internet that led to the greatest expansion of capital growth the country ever saw. Although high-tech standard-bearers, such as Intel, Cisco, and Oracle, were driving organic growth in the technology sector, it was upstart dotcom companies that fueled the stock market surge that began in 1995.

The bubble that formed over the next five years was fed by cheap money, easy capital, market overconfidence, and pure speculation. Venture capitalists anxious to find the next big score freely invested in any company with a “.com” after its name. Valuations were based on earnings and profits that would not occur for several years if the business model actually worked, and investors were all too willing to overlook traditional fundamentals.

Companies that had yet to generate revenue, profits, and, in some cases, a finished product, went to market with IPOs that saw their stock prices triple and quadruple in one day, creating a feeding frenzy for investors.

The Nasdaq index peaked on March 10, 2000, at 5048—nearly double over the prior year. Several of the leading high-tech companies, such as Dell and Cisco, placed huge sell orders on their stocks when the market peaked, sparking panic selling among investors. Within a few weeks, the stock market lost 10% of its value.²

As investment capital began to dry up, so did the lifeblood of cash-strapped dotcom companies. Dotcom companies that reached market capitalizations in the hundreds of millions of dollars became worthless within a matter of months. By the end of 2001, a majority of publicly-traded dotcom companies folded, and trillions of dollars of investment capital evaporated.

The dotcom bubble, also known as the Internet bubble, grew out of a combination of the presence of speculative or fad-based investing, the abundance of venture capital funding for startups, and the failure of dotcoms to turn a profit. Investors poured money into Internet startups during the 1990s hoping they would one day become profitable. Many investors and venture capitalists abandoned a cautious approach for fear of not being able to cash in on the growing use of the Internet.

With capital markets throwing money at the sector, start-ups were in a race to quickly get big. Companies without any proprietary technology abandoned fiscal responsibility. They spent a fortune on marketing to establish brands that would set them apart from the competition. Some start-ups spent as much as 90% of their budget on advertising.

Record amounts of capital started flowing into the Nasdaq in 1997. By 1999, 39% of all venture capital investments were going to Internet companies. That year, most of the 457 initial public offerings (IPOs) were related to Internet companies, followed by 91 in the first quarter of 2000 alone. The high-water mark was the AOL Time Warner megamerger in January 2000, which became the biggest merger failure in history.

The bubble ultimately burst, leaving many investors facing steep losses and several Internet companies going bust. Companies that famously survived the bubble include Amazon, eBay, and Priceline.

The dotcom bubble was a rapid rise in U.S. technology stock equity valuations fueled by investments in Internet-based companies during the bull market in the late 1990s. The value of equity markets grew exponentially during this period, with the technology-dominated Nasdaq index rising from under 1,000 to more than 5,000 between the years 1995 and 2000. Things started to change in 2000, and the bubble burst between 2001 and 2002 with equities entering a bear market.

The crash that followed saw the Nasdaq index, which rose five-fold between 1995 and 2000, tumble from a peak of 5,048.62 on March 10, 2000, to 1,139.90 on Oct. 4, 2002, a 76.81% fall.² By the end of 2001, most dotcom stocks went bust. Even the share prices of blue-chip technology stocks like Cisco, Intel, and Oracle lost more than 80% of their value. It would take 15 years for the Nasdaq to regain its peak, which it did on April 24, 2015.

KEY TAKEAWAYS

• The dotcom bubble was a rapid rise in U.S. technology stock equity valuations fueled by investments in Internet-based companies in the late 1990s.
• The value of equity markets grew exponentially during the dotcom bubble, with the Nasdaq rising from under 1,000 to more than 5,000 between 1995 and 2000.
• Equities entered a bear market after the bubble burst in 2001.
• The Nasdaq, which rose five-fold between 1995 and 2000, saw an almost 77% drop, resulting in a loss of billions of dollars.
• The bubble also caused several Internet companies to go bust.

In the year 1841, the author Charles Mackay published his classic analysis, Extraordinary Popular Delusions and the Madness of Crowds. Among other phenomena, Mackay (who never lived in or visited Holland) documents asset price bubbles—the Mississippi Scheme, the South Sea Bubble, and the tulipmania of the 1600s. It is through Mackay’s short chapter on the subject that it became popularized as the paradigm for an asset bubble.

Mackay makes the point that sought-after bulbs of particular rarity and beauty did sell for six figures in today’s dollars, but there is actually little evidence that the mania was as widespread as has been reported. The political economist Peter Garber in the 1980s published an academic article on the Tulipmania. First, he notes that tulips are not alone in their meteoric rise: “a small quantity of … lily bulbs recently was sold for 1 million guilders ($480,000 at 1987 exchange rates),” demonstrating that even in the modern world, flowers can command extremely high prices.

Additionally, because of the timing in tulip cultivation, there was always a few years of lag between demand pressures and supply. Under normal conditions, this wasn’t an issue since future consumption was contracted for a year or more in advance. Because the 1630’s rise in prices occurred so rapidly and after bulbs were already planted for the year, growers would not have had an opportunity to increase production in response to price.

Earl Thompson, an economist, has actually determined that because of this sort of production lag and the fact that growers entered into legal contracts to sell their tulips at a later date (similar to futures contracts), which were rigorously enforced by the Dutch government, prices rose for the simple fact that suppliers couldn’t satisfy all of the demand. Indeed, actual sales of new tulip bulbs remained at ordinary levels throughout the period. Thus, Thompson concluded that the “mania” was a rational response to demands embedded in contractual obligations.

Using data about the specific payoffs present in the contracts, Thompson argued that “tulip bulb contract prices hewed closely to what a rational economic model would dictate…Tulip contract prices before, during, and after the ‘tulipmania’ appear to provide a remarkable illustration of ‘market efficiency.” Indeed, by 1638, tulip production had risen to match the earlier demand, which had by then already waned, creating an over-supply in the market, further depressing prices.

The historian Anne Goldgar has also written on the Tulip mania, and agrees with Thompson, casting doubt on its “bubbleness.”⁵ Goldgar argues that although tulip mania may not have constituted an economic or speculative bubble, it was nonetheless traumatic to the Dutch for other reasons. “Even though the financial crisis affected very few, the shock of tulipmania was considerable.”

In fact, Goldgar goes on to argue that the “Tulip Bubble” was not at all a mania (although a few people did pay very high prices for a few very rare bulbs, and a few people did lose a lot of money as well). Instead, the story has been incorporated into the public discourse as a moral lesson, that greed is bad and chasing prices can be dangerous. It has become a fable about morality and markets, invoked as a reminder that what goes up must go down. Moreover, the Church latched on to this tale as a warning against the sins of greed and avarice; it became not only a cultural parable, but also a religious apologue.

The obsession with tulips—referred to as “Tulipmania”—has captured the public’s imagination for generations and has been the subject of several books including a novel called Tulip Fever by Deborah Moggach. According to popular legend, the tulip craze took hold of all levels of Dutch society in the 1630s. A Scottish journalist Charles Mackay, in his famous 1841 book Memoirs of Extraordinary Popular Delusions and the Madness of Crowds, wrote that “the wealthiest merchants to the poorest chimney sweeps jumped into the tulip fray, buying bulbs at high prices and selling them for even more.”

Dutch speculators spent incredible amounts of money on these bulbs, but they only produced flowers for a week—many companies formed with the sole purpose of trading tulips. However, the trade reached its fever pitch in the late 1630s.

In the 1600s the Dutch currency was the guilder, which preceded the use of the euro. At the height of the bubble, tulips sold for approximately 10,000 guilders. In the 1630s a price of 10,000 guilders equated roughly the value of a mansion on the Amsterdam Grand Canal.

By the end of 1637, the bubble had burst. Buyers announced they could not pay the high price previously agreed upon for bulbs and the market fell apart. While it was not a devastating occurrence for the nation’s economy, it did undermine social expectations. The event destroyed relationships built on trust and people’s willingness and ability to pay.¹

According to Smithsonian, Dutch Calvinists painted an exaggerated scene of economic ruin because they worried that the tulip-driven consumerism boom would lead to societal decay. They insisted that such great wealth was ungodly and the belief remains to this day.

Tulips first appeared in Europe in the 16th century, arriving via the spice trading routes that lent a sense of exoticism to these imported flowers that looked like no other flower native to the continent.² It is no surprise then that tulips became a luxury item destined for the gardens of the affluent: according to The Library of Economics and Liberty, “it was deemed a proof of bad taste in any man of fortune to be without a collection of [tulips].”

Following the affluent, the merchant middle classes of Dutch society (which did not exist in such developed form elsewhere in Europe at the time) sought to emulate their wealthier neighbors and, too, demanded tulips. Initially, it was a status item that was purchased for the very reason that it was expensive.

But at the same time, tulips were known to be notoriously fragile, and would readily die without careful cultivation. In the early 1600s, professional cultivators of tulips began to refine techniques to grow and produce the flowers locally, establishing a flourishing business sector, that has persisted to this day.

According to Smithsonian Magazine, the Dutch learned that tulips could grow from seeds or buds that grew on the mother bulb. A bulb that grew from seed would take seven to 12 years before flowering, but a bulb itself could flower the very next year. So-called “broken bulbs” were a type of tulip with a striped, multicolored pattern rather than a single solid color that evolved from a mosaic virus strain. This variation was a catalyst causing a growing demand for rare, “broken bulb” tulips which is what ultimately led to the high market price.

In 1634, tulipmania swept through Holland. The Library of Economics and Liberty writes, “The rage among the Dutch to possess [tulip bulbs] was so great that the ordinary industry of the country was neglected, and the population, even to its lowest dregs, embarked in the tulip trade.”

A single bulb could be worth as much as 4,000 or even 5,500 florins—since the 1630s florins were gold coins of uncertain weight and quality it is hard to make an accurate estimation of today’s value in dollars, but Mackay does give us some points of reference: among other things, 4 tuns of beer cost 32 florins. That’s around 1,008 gallons of beer, or 65 kegs of beer. A keg of Coors Light costs around $90, and so 4 tuns of beer ≈ $4,850 and 1 florin ≈ $150.⁴ That means that the best of tulips cost upwards of $750,000 in today’s money (but with many bulbs trading in the $50,000 – $150,000 range). By 1636, the demand for the tulip trade was so large that regular marts for their sale were established on the Stock Exchange of Amsterdam, in Rotterdam, Haarlem, and other towns.

It was at that time that professional traders (“stock jobbers”) got in on the action, and everybody appeared to be making money simply by possessing some of these rare bulbs. Indeed, it seemed at the time that the price could only go up; that “the passion for tulips would last forever.” People began buying tulips with leverage, using margined derivatives contracts to buy more than they could afford. But as quickly as it began, confidence was dashed. By the end of the year 1637, prices began to fall and never looked back.

A large part of this rapid decline was driven by the fact that people had purchased bulbs on credit, hoping to repay their loans when they sold their bulbs for a profit. But once prices started their decline, holders were forced to liquidate—to sell their bulbs at any price and to declare bankruptcy in the process. Smithsonian Magazine indeed notes that “[h]undreds who, a few months previously had begun to doubt that there was such a thing as poverty in the land suddenly found themselves the possessors of a few bulbs, which nobody would buy,” even at prices one-fourth of what they paid. By 1638, tulip bulb prices had returned to from whence they came.

The Dutch tulip bulb market bubble, also known as ‘tulipmania’ was one of the most famous market bubbles and crashes of all time. It occurred in Holland during the early to mid-1600s when speculation drove the value of tulip bulbs to extremes. At the height of the market, the rarest tulip bulbs traded for as much as six times the average person’s annual salary.

Today, the tulipmania serves as a parable for the pitfalls that excessive greed and speculation can lead to.

KEY TAKEAWAYS

• The Dutch Tulip Bulb Market Bubble was one of the most famous asset bubbles and crashes of all time.
• At the height of the bubble, tulips sold for approximately 10,000 guilders, equal to the value of a mansion on the Amsterdam Grand Canal.
• Tulips were introduced to Holland in 1593 with the bubble occurring primarily from 1634 to 1637.
• Recent scholarship has questioned the extent of the tulipmania, suggesting it may have been exaggerated as a parable of greed and excess.

Tulipmania is frequently used as a metaphor for other speculative bubbles, particularly when the subject of the bubble has no clear economic value. Similar cycles have been observed in the price of Beanie Babies, baseball cards, non-fungible tokens (NFTs), and shipping stocks.

A notable parallel occurred during the dotcom bubble of the early 2000s when investors poured money into the tech sector. Due to the mysterious and poorly understood promise of the Internet, these investors found themselves putting money into companies with no revenue stream and no clear business model.

Another example is the derivatives bubble that preceded the global financial crisis of 2008. Due to the complexity of the derivatives markets, hedge funds and banks underestimated their risk exposure, causing the market to collapse when the underlying debts defaulted.

Some argue that the high prices of bitcoin and other cryptocurrencies show similarities to a tulip-like bubble.

Some historians have cast doubt on the historicity of tulipmania, suggesting that popular accounts may have fabricated or exaggerated the real event. Anne Goldgar, a historian at King’s College London, found that “there weren’t that many people involved and the economic repercussions were pretty minor.” Had there really been a tulip-based economic collapse, there would have been much larger ripple effects in the wider economy. Instead, Goldgar “couldn’t find anyone that went bankrupt.”

An alternative explanation is that the size of the bubble was inflated by Dutch Calvinists, who frowned on the profiteering of the Amsterdam stock market and viewed the tulip bubble as a warning against capitalistic excess.