Notes for Economics
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To understand what continues to happen today,
let’s look at the more distant past. One
of the most famous bubbles in history is the
Dutch Tulip-Bulb Craze of the early seventeenth
century. The Tulip Craze reflects simple idiocy
coupled with the stupidity of crowd mentality.
Though most of us identify tulips with Holland,
they were not indigenous to that country.
Originally, tulips came to Holland from Turkey
in 1593, imported as a luxury good. However,
given their new environment, many bulbs succumbed
to a disease a color-breaking virus that is
transferred by feeding insects.
It causes the petal pigmentation to break
into flame-like multi-colored stripes. The
Dutch prized these patterns. Since tulip bulbs
are perennials, the bulbs preserved their
uniqueness and perceived value due to a scarcity
of the patterns that were the most prized.
As with any rare product of fixed supply,
increased demand caused a rise in the market
price. Bulb merchants stockpiled the most
popular patterns and held them back from the
market artificially. In effect, the phenomenon
of “Tulip Mania” resulted from hoarding,
which led to an escalation in prices.
To invest in bulbs, Dutch citizens liquidated
good stores of value. Purchasing frenzy caused
bulb prices to reach astronomical levels.
As market demand outran investment capital,
speculators developed a method of call options.
These required only a down-payment of the
purchase price. In January 1637, margin-buying
spurred bulb prices to rise twenty-fold. However,
the bubble finally burst: During the following
month, prices plummeted twenty-fold.
As the market tumbled, the market equity positions
of investors evaporated. Panic ensued. Investment
funds fell into bankruptcy as they failed
to honor their call options. Faced with a
collapsing financial market, the Dutch government
intervened and attempted to settle contracts
at 10% of their purchase price. Unfortunately,
market prices continued to fall, dropping
below the government price-floor until bulb
prices settled to that of a common onion.
The Tulip Craze mimicked the behavior of other
bubbles that have occurred in the present
day. First, market speculation built slowly
with a gradual ascent in prices. Second, the
number of investors increased. That fueled
progressive speculation. Third, speculators
introduced margin-buying that helped the market
to grow exponentially. Fourth, as the bubble
developed, the market rose rapidly to spiked
prices. Fifth, that bubble burst and market
price collapsed rapidly due to a contemporaneous
failure to meet margin calls.

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