The Hindu Business Line : Flower power

Writers who profile financial manias can seldom resist the temptation to start with the Tulip mania of the 1600s. Tulip mania is a tale of how free markets, when not reined in, can wreak havoc on wealth and even society. Popular accounts of ‘Tulip mania’ portray an entire nation crazed and bidding for flowers and ultimately driving their prices sky high.

The ensuing crash in their prices was said to have bankrupted a nation. Most references to the Tulip mania cite Charles Mackay’s more popular account which uses this to describe how unfettered markets can lead to wild pricing. However, a more detailed and sober account by Anne Goldgar holds some subtle, yet valuable, lessons for investors.

Tulip exchanges

Here’s the tale of the Tulip mania. In the early 1600s, the price of several varieties of tulip bulbs were bid up several-fold on the back of heavy demand. In fact, certain varieties of tulips multiplied 12-fold between December 1636 and February 1637. There is even the case of a variety of tulip — Groot Gepluymaseerde — which saw its prices double in just two weeks!

Goldgar’s account suggests that Mackay’s account may be somewhat exaggerated. Firstly, the tulip was not a flower which appeared out of the blue and swept the Dutch off their feet.

Several varieties of the tulip bulb had appeared over 50 years, leading up to the crisis. They were used as gifts and on early occasions traded by individuals.

What actually brought the mania to a head was a newly affluent Dutch society, in the midst of the ‘Dutch golden age’. With trading fuelling the Dutch to the forefront of the global economy in the 1600s, the Tulip mania was a largely urban phenomenon with huge transactions happening in Amsterdam and Harleem.

Discussion and bidding for tulips happened in inns and taverns, which doubled up as informal “tulip exchanges”. The keepers of these inns often served as witnesses for the tulip transactions. The participants in a majority of these transactions were textile traders, brewers, artists and craftsmen.

Tulips remained in the ground for a large part of the year only to be dug out in May or June and, for longevity, replaced in the ground . Transactions would take place over the winter, with the buyer and seller agreeing on a price during winter for a bulb that would be harvested three-four months later.

The early beginnings of a “futures” market? The price of each Tulip was set based on the size, shape, colour and pattern of the expected flower. All four ‘features’ were subject to guesses, as very little knowledge on genetics or physiology existed then.

Soon, trading for tulips became a highly profitable venture and partnerships began to emerge. As the famous comparisions go, 1,000 florins ($12,000) could buy you 12,500 kilos of bread or a single Tulip.

Another comparison involved how two measures of wheat, four of rye, four fat oxen, eight fat pigs, twelve ox heads of wine, 3800 litres of beer, and so on, plus a ship to carry them in could buy a single viceroy tulip bulb! Why did prices climb so high? Well, one theory even has it that euphoria from having survived the plague aided the frenzy for Tulips!

How, then, did the crash happen? There are several theories, including one that a bidding war of less-than-expected enthusiasm led to a dominoes effect on Tulip prices. Finally, when the crash came along, several obese check books turned pleasantly plump. Business did slow down, bankruptcies (often wrongly attributed to the tulip mania) did happen. But tulip trading did not end….

What’s in it for investors

While it may appear silly for investors to have paid a fortune in December for flowers they could only see next summer, do note that many modern futures contracts are similar. When we bet on the September futures of Reliance, we are betting that the underlying assets will be worth more! This is not unlike paying for Tulips in December which one can see only in March.

The sane explanation could be that whether it is Tulips or shares, the price one is willing to pay for them is as much a product of psychology as it is of valuation. As Goldgar puts it, “value is a cultural construct”.

The concept of ‘good faith’, that is buyer and seller sticking to their end of the bargain, plays an important role in market confidence. When ‘good faith’ is tested by an event- like the crash in Tulip markets- the market fabric begins to unravel.

For the more cynical investor, Charles Mackay had a useful line ‘Men, it has been said, think in herds; it will be seen go mad in herds, while they only recover their senses slowly and one by one.’

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