The Tulip Mania and where are we right now
Year 1636 - You can buy a villa with a Tulip Bulb.
In this article, I will explain “The Tulip Mania” and compare it with the present time securities/components or hyped as valuable items such as NFTs and why the stock market is not a bubble.
- What is a financial bubble?
- History of “The Tulip Mania”.
- The first bubble burst with 95% down in one night
What is a financial bubble?
Let’s say you have a bitcoin and the year is 2015 and that cost you $100, a little later you sell that bitcoin for $150, earning a profit of $50, you meet with friends and tell them how you made $50 with bitcoin, your friends, of course, wanted profits, so they buy a bunch of bitcoin, hoping to sell it at the higher price, after a week they sell it at $200 for each bitcoin, and then new people came in to buy bitcoin hearing of all the profits being made, over time more and more people will come in, each person is betting they will be able to sell at a higher price to the next person but eventually you run out of the buyers, you run out of the next person and the price goes down, it crashes, this is an economical bubble.
Information cascade is a phenomenon that occurs when people make their decision based on rational inferences made using information about the decisions of others.
Information cascade still exists today and will be forever, and that is causing bitcoins & shitcoins to rise, retail investors running after penny stocks, these are the results of heavy marketing, the hype about some components at the higher value at which they are not and people feel FOMO(fear of missing out) and they follow the false market gurus and the cycle goes on.
History of tulip mania?
The year 1637, the Golden Age of the Dutch Republic.
In this golden age, the early capitalism concepts were started and it is the age of the foundation of the first companies and the first stock exchange created and also the birthplace of the first bubble burst.
The tulip was originally from Persia and traded to western Europe in the 16th century. Tulips were attractive and has lots of variety, and they rapidly became prized above all other flowers. The dutch republic saw the opportunity of the rise of the new middle class, and they knew that the merchants and traders will willing to pay large sums of money for a variety of tulips.
Due to the Dutch East India Company, wealth was flowing in that period. By the 1620s a new variety of flowers has emerged “Semper Augustus” and the Semper Augustus was owned and grown by only one man, he knew the market very well if he sells his tulips, the customers will do experiments and make the offsprings which will eventually lead to more competitors, meaning that the owner would have to lower his price to compete with competitors.
The innovation of the first trade contracts.
The owner made strategy what most of the companies do, now the owner of the Semper Augustus created a monopoly, meaning that he was the only one who was able to sell the “Semper Agustus”.
But how did he managed to do this, how did he sell the tulip, while being a monopoly?
The owner of the Semper Augustus created a special contract.
The buyers were not allowed to sell the tulip without the express permission of the original owner.
The buyers weren’t allowed to sell any of the offspring from the tulip bulbs to others.
The contract was a success, as a result, the prices went up.
So how much did the prices went up, can a tulip bulb buy a house, horses, or more?
It went so high, that a professional artisan such as a carpenter would have to work 10 years and his earning is 300 guilders per year, and without spending a single penny not even on food or anything and then after 10 years he would have enough money to but a single tulip bulb.
In modern-day money, a single bulb of tulip of “Semper Agustus” can cost you around $4,85,400 that’s more than 1 BTC = 45,139.80 USD.
1 Tulip Bulb = 44,85,400 USD = 1620s1 BTC = 45,139 USD = 2021
The problem with Tulip farming and innovation of “Futures Contract”
The problem with tulip is that it was once in a year crop and until it fully bloomed, owners didn’t know what and how the tulip is going to look like, as the appearance and variety are the main factors.
To solve this problem a new type of contract was created “Futures Contract”.
A futures contract is a contract, where the buyers purchase a product and then sellers deliver the product once it is ready.
In finance, a futures contract (sometimes called futures) is a standardized legal agreement to buy or sell something at a predetermined price at a specified time in the future, between parties not known to each other. ... A stock future is a cash-settled futures contract on the value of a particular stock market index.
In the case of tulips, buyers can sign a contract for a tulip bulb, but the buyers don’t take possession of the tulip bulb, because the tulip bulbs were not grown while signing the contract the buyer has to wait until the flowers.
Well since buyers have the contract, which states that the owner of the contract is the owner of the tulip. Anyone can sell the contract. A futures contract states that the bearer of the contract is also the owner, so when you sell the contract to someone else and now the buyer is the owner of the security/product/tulip.
If you were there in the 1620s why would you buy a tulip bulb if you don’t even know whether it is the one you wanted to sell?
A futures contract has the advantage, that as the buyer you can buy the product at lower prices in exchange for taking extra risk. As the seller, you reduce your risk by selling early and so you are assured to make profits.
Around the year 1634, people have slips of paper stating the ownership of a tulip bulb, with a slip of paper you could easily trade a tulip bulb, you no longer need to wait until the flowers to bloom, you could now sell it any time.
As a result of the futures contract, now people were trading more & more, prices were going high and creating the longest bull run. Now, this was only between the traders and the people who were in the business.
Now the general public get aware of the profits and the contracts, they started buying and many new traders entered the tulip market. As the prices grew, more and more people who knew very little or nothing about tulips wanted to get into the profitable tulip trade.
Now the futures contracts were changes and updates as lot sizes, now the contract states that you can own in a lot size, 1 lot container 10 to 50 tulip bulbs.
By the end of 1636, the prices were so high that if you were in Europe at that time you can buy an entire street with a couple of medium or high-quality tulips bulbs.
Tulip has value because it’s pretty but it’s not valuable as ten years of salary.
This is what makes a bubble a bubble - the actual value of the product is a lot slower than the amount of money for which it is traded and the price was just going up endlessly.
The 95% fall in one night and initiation of the Bubble Burst
Evening, February 5th, 1637, Harlem of the Dutch city.
Traders were ready to start the trading and bidding, at the INN tuned exchange office. The first trader comes with a valuable tulip breed less than half a gram, not even close to mature yet, 1 buyer comes with buying price of 56 guilders.
The second trader started selling his contract, the contract states that the owner of the tulip bulb can collect the bulb, weighing about 5 grams, not matured yet. Nobody wants to take the risk, so the order was closed for 10 guilders.
The third seller started bidding with matured bulbs weighing 50 grams because the second-order of the bulbs were low, it’s obvious that buyers now want to buy at a lower price than previous. so the order was even closed for as low as 6 guilders.
The men at the Inn starting getting nervous, panicking the prices are going down, they have tulips of their own tulip that are far worth less than at the beginning of the evening so they decide to sell the tulips now instead of the prices drop down even further. The price is continuously falling because there are now more tulips being sold, so now in order to compete with other traders they now have to lower the prices getting lower more traders to sell their tulips, they are forced to lower the prices even more leading to more selling leading to lower prices.
At the end of the night, prices have fallen down to 95% in the span of 6-8 hours. Prices crashed across the countries within 4 days the bubble has burst across the dutch republic. And the most common bubble burst you know about are :
Dot Com bubble (US) 2000s
United States housing bubble (US) (2002–2006)
Issac Newton also lost £20,000 (or more than $3 million, based on the money value in 2002-03) in the South Sea bubble burst.
Throughout history, many financial crises have come and go and they will be always there because the pattern occurs every 10-15 years. And history don’t repeat itself, the people make the same mistakes.
During the tulip bubble, there were prominent traders who everybody looked up to as a source of trustworthy information, and the prominent traders said that tulips are a good investment.In 2008, the crisis of the United States Housing Bubble, happened because the people at that time tested the trustworthy rating agency or so-called subprime mortgages, they said that they were good and safe investments, and borrowers trusted them to be a safe investment, what it turned out to be, they were not safe, the bubble bursted and economic crisis happened. If you have watched the movie you know the whole process of how the bubble busted and how much the actual loss was.
“You know what I hate about fucking banking? It reduces people to numbers. Here's a number - every 1% unemployment goes up, 40,000 people die, did you know that?”
- Ben Rickert (The Big Short)
Even stocks/shares, golds, real states have value because these can be used in real life and such stocks are the actual valuation of companies and directly related to business and economic growth, gold is used for jewelry and microchips in integrated systems, house and real estate are valuable for people as roof and infrastructure. Look around and see what’s going on what people are investing too much which everyone knows that it’s not valuable but still trading for millions.
This asset can be a bubble if numbers are manipulated and spreading wrong information, but no one can see a bubble.
"No one can see a bubble. That's what makes it a bubble."