Tulip Mania: Dutch Crowds Feed a Speculation Bubble

The classic example of the scheme that is set up to look economic but that turned into a Ponzi, which turned into a credit bubble was the Tulip Mania in the mid-sixteen hundreds. We are far away enough from it and have a clearer historical perspective.

In 1630 – 1636 there was a beginning middle-class in the Netherlands. There was an overall sense among the middle class of a right and a natural order to ever increasing prosperity. They saw an economic boom unlike any other and felt this time was different. It wasn't going to go bust. What was available for the middle-class to save their capital wasn't the banks and appropriate safe investment vehicles. What was available was investing in tulips. Tulips were highly prized because of an oddity. When you planted a tulip, you didn't quite know what you were going to get. Because of a virus that spread, you didn't know when you planted a tulip if you would get a pure color or wild streaks when it came up. There was a gamble in just what kind of tulip you would get.

The Dutch created a type of futures market where options or contracts to buy bulbs were bought and sold. What happened was that there became a shadow auction. Formal auctions had to have a lot of money and you had to be a well-established breeder to attend. The shadow auctions took place late at night. There were credit requirements but you had no regulations looking into the quality of credit. So you had these people selling tulips that they don't own to people who don't want to buy them, paying with money that they didn't have. And you had this huge inflation of tulip bulbs. Sometime tulip bulb prices would double in just a two-week period.

The whole thing came crashing down in January or February of 1637 when a few people decided to take their profits and run.

From a contemporary point of view, you had all of these contracts out there requiring investors to pay enormous sums for tulip bulbs. Entrepreneurs wanted those contracts enforced.

Eventually the Dutch parliament decided that for policy reasons, the government would not allow the contracts to be enforced through the courts. They ruled that futures speculators were gambling and should sort out the consequences on their own. Parliament ruled to treat such speculation like other gambling debts, that is, the futures contracts were not enforceable.