The First Financial Crisis: Tulip Mania
When you hear the words “financial crisis,” the first thing that comes to mind might be the stock market crash of 1929, the 2008 housing bubble, or another significant financial event in history. The first financial crisis actually did not involve stocks, mortgage loans, or anything else you might initially guess. The first financial crisis began in Holland in the seventeenth century over one unexpected commodity: tulip bulbs. This blog is part of a series written by our summer intern, Makenna. This series is based off excerpts from the well-known book, A Random Walk Down Wall Street.
The First Financial Crisis: Tulip Mania
In the early 1600s, a unique (and pricey) form of tulip grew in popularity in Holland. What made these Dutch garden staples so desirable was the stunning “flame” design created by the mosaic virus, also known as Tulip Breaking Virus. The Dutch began demanding more wild, intricate designs for these tulips and were willing to pay a steep price for them. High demand created a need for suppliers. Everyday people who had never been involved in tulip bulb sales or any kind of gardening work began using tulip bulbs as investments by purchasing large amounts of them hoping to make a profit from rapidly increasing prices. The demand grew so quickly that tulip bulb sellers would sell or trade valuable belongings including land just to stock up on what they speculated would be the next popular tulip design. It sounds a bit ridiculous that people would be willing to risk everything for a plant, but at the time, prices were rising so high that it was hard to resist investing in something so profitable.
More reasons for the craze were the “call options” available for purchasing tulip bulbs. Much like call options in the stock market, anyone could purchase the right to buy bulbs at a certain price no matter the market price. Call options are desirable when the market price is expected to increase rapidly. For instance, if the market price for tulip bulbs was 500 guilders, a call option could be purchased for roughly 20% of this number, or 100 guilders. When the market price rose to the holder’s preferred height, possibly 1,000 guilders, then the holder could buy the 1,000 guilders valued tulips at the purchased price of 500 guilders. Finally, the holder would immediately sell the tulips for the current market price and end up with a profit of 400 guilders (1000 sell price – 500 tulip purchase – 100 call option purchase). Rather than investing 500 guilders to begin with, the holder purchased the much less risky and less expensive right to buy the tulips at a set price no matter the current price.
By the height of tulip mania in January 1637, the rarest bulbs were selling for “as much as six times the average person’s annual salary” (Source). One month later, prices plummeted to less than 20% of the peak price. People began to realize that tulips were not as valuable as the market had speculated, so they panicked and sold their stock of bulbs. Prices continues to dwindle until the tulips were practically worthless. As a result of the sharp decrease in price, countless people lost money, land, and other belongings because they invested their valuables into tulip bulbs that they could no longer sell.
Don’t Fall for “Get Rich Quick” Schemes
The most important takeaway from the first financial crisis is to avoid the temptation of “get rich quick” schemes. Buying ridiculous amounts of tulips because the price was rising may have sounded like a good idea during the height of tulip mania, but most financial phenomena are short-lived. Although modern investing was not an option in the 1600s, we now have much better investing alternatives than crowd speculation and “get rich quick” schemes. If you find yourself tempted to invest in the newest financial craze, I encourage you to consider the devastating results of tulip mania. Keep your money safe and make educated investing decisions, so you do not lose it all on one fleeting trend in the market.
Summer Intern / Berry College Student