Bubbles in Asset Prices - Why Do People Speculate?
Mike Dash wrote a wonderful about the Tulip Bubble in Holland, which occurred between 1634 and 1637. Many of the things we believe about the Dutch tulip mania turn out to be false. There was no widespread bankruptcy, no devastating loss of credit. In a few years after the crash, Dutch growers were selling their bulbs to a wider market -partly because of the infamous reputation of the tulip.
Dash puts the tulip in historical context, and discusses briefly other tulip like manias - which like viruses lay dormant only to reappear under the right conditions.
What are those conditions?
Dash describes the Tulip Mania as resulting from the following factors:
a) The trade in tulips started off as bulb exchange, physical commodities. But the bulbs in question had an odd property - at random and undetectable, because of an undetected virus- the bulbs would change their properties, from dull unicolors to wildfire colours. There was an essential randomness about the product. But the original trading season was short- between growers and horticulturists.
b) There was an extraordinary belief, for the period and time, that "social mobility was the birthright of every Dutchman."
c) The Dutch had both a propensity to save and gamble.
d) The bulbs bought and sold in 1630's were not the out and out rarities, which were limited in numbers. This was a market in futures, which was technically illegal at the time. The Government had tried to prevent several times. It was believed that futures were like naked shorts - selling what you didn't have.
e) The actual tulip mania last from 1634 to January, 1637 - when the price of a bulb could double in a week between December 1636 and January 1637.
f) What was being sold, by the florists, from 1634 to 1637 were promissory notes. As described by by Dash "it became perfectly normal for florists to sell tulips they could not deliver to buyers how did not have the cash to pay for them and had no desire ever to plant them."
g) The margin requirements for purchase was 10% down, but there were no other credit checks.
h) The peculiarity of the auction, yes conducted in Taverns, favoured accepted reasonable bids.
i) In the end, the Government suspended the legal enforcement of the contracts, to allow the individual provinces the time to "investigate" the problem. It appears that most growers eventually accepted 3 cents on the dollar in compensation for the right to cancel the sale.
j) The local banking economy was not threatened by this mania- there weren't any banks. So there were few alternatives to investing surplus cash.
Dash's book contains a wealth of interesting details, and I recommend it.
