In economics, the bubble metaphor is one that tends to incite fear, anxiety and even excitement. In the last two decades alone we’ve witnessed two of history’s most prominent economic bubbles ‘burst’- the Dotcom in 2002, and more recently the American housing one in 2009.
So what exactly is an economic bubble? And when does it take place? In short, an economic, or financial bubble occurs when the price of an asset strays too far from its fundamental value. Speculators invest in an asset with the belief its value will increase over a short period of time. As the demand for the asset increases, its price goes up.
At its peak, the asset price is completely removed from what it was worth initially and intrinsically, and could probably ever be sold for again. When the demand inevitably drops as the price becomes too high for investors to buy- the bubble bursts. It leaves many bankrupt, in debt, and in possession of valueless assets.
The Dutch bubble burst first
We can cast our gaze back to the booming Dutch economy of the 17th century for an historical case study. It’s here where the nation’s love affair with the tulip all began. ‘Tulipmania’ as it is known today is generally cited as being the first example of an economic, or financial bubble.
The tulip was introduced to the Dutch via Ottoman Empire traders. The exotic and alluring plant caught the attention of Holland’s upper classes, who sought the rarest bulbs as status symbols. Interest in horticulture had become a fashion preoccupying wealthy connoisseurs and amateur botanists, who began to cross-breed to try and conjure the most vivid colours and patterns.
These exciting and captivating varieties of tulip did more to heighten the interest. The disposable income of Holland’s middle class of bankers and merchants provided a pool of wealth for investment. Tulip brokerages were set up as the fashion propagated in the then-richest country in Europe, and people started to buy them in droves.
As interest grew, the demand was further amplified by the fact that savvy investors were turning their attention towards the bulbs rather than the flowers themselves (as many economists would point out, the first example of ‘futures markets’). Rarer strands of tulip such as the fabled Semper Augustus were already worth around 5,500 guilders (approx. $3000) a bulb in 1633. The frenzied buying and selling of this aesthetic commodity saw the value of one Semper Augustus bulb almost double in the first month of 1637 to 10,000 guilders (approx. $5400). Other reports state that at one point other tulip bulb prices skyrocketed by 1,100% in a single month that year.
A flower worth more than a house
To place this in context, the value of one bulb at the height of the mania was enough to buy one of the grandest homes on the thriving Amsterdam canal, which would have been one of the most expensive places in the world at the time for property. Inevitably, the rising prices had to hit a ceiling at some point.
In February 1637, the market for tulips collapsed- primarily because people could no longer afford to purchase even the cheapest bulbs on the market. As the demand declined, bulbs tumbled to a tenth and more of their former values. Disputes over debts lasted for years after the crash, and many involved plunged into severe debt.
Unlike the economic crash in 2008, which crippled the American and other national economies, it didn’t quite have the dent on the affluent Dutch economy that more recent financial bubbles have inflicted on society. While it left many with crippling debt, and some confused owners of muddied tulip bulbs, for most it acted more of a morality tale, and made many cautious of speculative trading.
Why did it happen?
Scholarly theories as to the causes of the bubble vary, but some interesting estimations have been made. Some propose the fact that price speculation and initial trading of bulbs that launched the ‘mania’ probably started in taverns. Gambling binges tied to drinking games may have seen alcohol-laden and cash rich investors speculating as to the value of the bulbs they possessed. Some academics go as far as asking whether the outbreak of bubonic plague in Amsterdam had made people less risk-adverse.
Whichever theory you subscribe to, Tulipmania has certainly sealed its place in the history books as the first, and certainly not the last bursting of an economic bubble. Studying the history of economics is a great way to understand and predict patterns in the present and future. If you’d like to further your education in global economics and finance, you can enrol now on a short course to earn a certificate in Policy Issues in the Global Economy.