One of the most famous instances of an asset bubble was the ‘tulipmania’ that erupted in Holland during the 17th century. In the first recorded major financial bubble, demand for tulips exploded, and prices for the flowers followed suit.
This led some investors to speculatively purchase tulips, resulting in losses when prices fell back down.
But, what can a bubble burst from over two centuries ago teach us about market volatility? Here’s how the rise and fall of one flower turned a portion of Dutch traders on their head – and how modern investors experience the same “mania.”
What Is Tulip Mania?
Tulip Mania was a speculative frenzy that erupted in Holland during the 17th century. The Dutch were newly independent of Spain and building themselves into prosperous traders. The mid-1600s was a period of wealth for them, as they benefited from rare imports brought through the Dutch East India Company.
Interest in exotic items was at an all-time high, and collectors became fascinated with not just tulips but “broken” tulips. These tulips came from bulbs and grew into striped or multicolored patterns. As demand grew, more companies began selling bulbs.
The most famous tales about Tulip Mania sound like something out of a book. People of all walks of life bought the flowers in a frenzy at sometimes extremely high prices. They hoped for significant returns and to escape their social classes, but they met financial disaster. Those investors fell into ruin when the tulip bubble burst in 1637, and some of the stories even detail tragic endings; people losing everything and drowning themselves in the canals. All because a tulip-incited mass hysteria that created a financial crisis.
But, is it really true?
What Really Happened During Tulip Mania?
The “mania” in the story of Tulip Mania comes from an 1841 account by a Scottish author named Charles MacKay. His Memoirs of Extraordinary Popular Delusions and the Madness of Crowds detailed a “tulipomania” where people poured years of salaries into the speculative tulip trade. From farmers to nobles to chimney-sweeps, he documented every class buying in. Then, the memoir described mayhem following the market collapse in 1637. Ultimately, MacKay created a dramatic tale that was more fiction than fact.
There was a Dutch tulip bulb market during the Dutch Golden Age. However, traders were limited to buyers with the finances to invest in luxury items. Typically, this group included merchants, artisans, and the upper class.
Additionally, the price increase was not consistent. Between December 1636 and February 1637, some highly sought-after bulbs experienced a price spike. Some of the most expensive went for 5,000 guilders, which equaled the value of a nice home in 1637. Or, there is evidence that the highest bid totaled out to 5,200 guilders. That matched 20 times the yearly salary of a skilled worker. But these prices were the exception, not the rule.
That leaves the final part of the story: the fallout.
Tulip Mania Bubble Burst
Tulip Mania is the classic and most well-known historical example of a financial bubble. Traders bought into the bulbs with the intent to resell and earn a profit. However, the flowers’ held no inherent value. Their status as a luxury item determined their prices and pushed demand. In fact, demand grew so high that professional traders began bidding on the product on the Stock Exchange of Amsterdam. People even used margined derivative contracts to increase the number of tulips they could buy despite their financial limits.
But before spring even hit, the bubble burst. The mania fell away after the tulips lost their value when the supply of tulips increased due to warmer weather. With so many of the crops, bulb traders realized the product wasn’t as rare as they thought. An auction in Haarlem in February of 1637 seemed to solidify the thought when the auctioneers failed to sell any bulbs.
When the prices dropped, traders had to sell their holdings for a lower value. However, this led to a few broken relationships and lost reputations, not any tragic deaths.
So, there was no morbid end when the Tulip Mania bubble burst. MacKay reported that Holland’s national economy fell apart due to the volatile market crash, but those claims appear exaggerated. The bubble only impacted those who were involved in the Tulip trade, and most investors were in an easily salvageable position. They financially recovered relatively quickly. On the other hand, growers did struggle to replace the lost buyers when contracts fell through.
What Tulip Mania Reveals About Financial Markets
While the story is more straightforward than MacKay made many believe, it is still a valuable moment in economic history. It became a parable that explains the nature of bubbles and the crashes that occurred throughout the history of the stock market.
Part of its value as a lesson stems from its moment in time. Multiple bubbles followed Tulip Mania, including the railroad mania bubble during the 1840s, where commentators encouraged investors to buy into U.K. railway stocks or in the early 2000s when Americans began speculating in residential housing before that bubble burst.
The dynamics behind each of these events is similar to the dynamics of the tulip bubble. Speculators drive up the price of an asset beyond its intrinsic value until the bubble eventually busts and those who bought at the top of the market end up losing money in the market downturn.
Recommended: How Much Stock Market Fluctuation Is Normal?
The Takeaway
Bubbles can also occur in the pricing of individual securities, sectors, or the broader stock market, eventually leading to a crash in prices. A stock market crash is an alarming time that can send many investors into a panic. They see the drop and move immediately to selling.
However, panic selling in the face of market volatility can have disastrous effects on a portfolio. Either you sell when the market is struggling and earn lower returns as a result, or you miss out on the market rebound.
One way to minimize potential losses in a crash is to build a diversified portfolio with asset classes that don’t always perform the same way in different market conditions. You can get started on the SoFi Invest® brokerage platform, which allows you a portfolio that matches their specifications.
SoFi Invest supports the financial moves your long-term goals require.
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