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The
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folio
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The
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of
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Man
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ent 1
989.
16.1
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The
Jou
rnal
of
Port
folio
Man
agem
ent 1
989.
16.1
:53-
60. D
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The
Jou
rnal
of
Port
folio
Man
agem
ent 1
989.
16.1
:53-
60. D
ownl
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om w
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midst of all this misery that made our city suffer, people were caught by a special fever, by a particular anxiety to get rich in a very short period of time. The means to this were thought to be found in the tulip trade. This trade, so well known in the history of our country, and so well developed in our city should be taught to our fellow citizens as a proof of forefatherly folly.
Of the plague in Haarlem, van Damme notes that ”one can presume that the tulip futures specu- lation reached its peak when the plague was worst.” De Vries [1976, p. 2261 claims that the plague outbreak of 1635-1636 “perhaps by spreading a certain fatalism among the population kicked off the most frenzied episode of the mania.”
It is clear that the population of the Nether- lands faced a high probability of imminent death from 1635-1637, coincident with the tulip speculation, and a decline in the probability thereafter. Although the plague outbreak may be a false clue, it is conceivable that a gambling binge tied to a drinking game and general carousing may have materialized as a re- sponse to the death threat. Lacking is an explanation of why this loss of morale took the form of a game centered around tulip speculation and why it did not recur in later plague outbreaks. Also, contemporary descriptions of the tulipmania craze fail to mention the plague.
MODERN INVOCATIONS OF TULIPMANIA
Mackay’s tulipmania description has strongly influenced the attitude of participants and observers of the financial markets. In an introduction to Mac- kay’s book (whose reprinting he had encouraged), Bernard Baruch emphasizes the importance of crowd psychology in all economic movements. Dreman [1977] stresses psychological forces in asset price de- termination. Dreman constantly invokes the tulip- mania as a reference point in discussions of suc- ceeding major speculative collapses. He states (p. 52):
If, for example, my neighbor tried to sell me a tulip bulb for $5,000, I’d simply laugh at him. . . . The tulip craze, like the manias we shall see shortly, created its own reality as it went along. It is ludicrous to pay as much for a flower as one pays for a house’’
Malkiel [1985] extensively cites Mackay in a chapter entitled “The Madness of Crowds.” In ref- erence to other speculative episodes, he asks:
Why do such speculative crazes seem so iso- lated from the lessons of history? I have no apt answer to offer, but I am convinced that Bernard Baruch was correct in suggesting
that a study of these events can help equip investors for survival. The consistent losers in the market, from my personal experience, are those who are unable to resist being swept up in some kind of tulip-bulb craze (PP. 44-45),
Tulipmania made its first appearance in serious economics articles with the development of capital theory in the 1950s and the discovery of the potential existence of multiple, dynamically unstable asset price paths. Samuelson [1967, p. 2301 associates the tulip- mania metaphor with ”the purely financial dream world of indefinite group self-fulfillment,” The “sun- spot” literature has revived references to tulips as a motivation for the line of research. For example, Aza- riadis [1981, p. 3801 claims that:
The evidence on the influence of subjective factors is ample and dates back several cen-
Sea bubble in England, and the collapse of turies; the Dutch “tulip mania,” the South
the Mississippi Company in France are three well-documented cases of speculative price
57 5 y1 E
movements which historians consider un- warranted by ”objective” conditions.
In his presidential address to the American Fi- nance Association, Van Home [1985], citing a series of anomalies that have cropped up in recent research on returns in financial markets, embraced the possi- bility of bubbles and manias. In an example he refers explicitly to tulipmania, when a “single bulb sold for many years’ salary.” Shiller [1986] argues that the standard and accurate view, until the last few de- cades, has been that asset markets are driven by capri- cious investors acting on the basis of fads and bubbles. As one example, he provides a quotation of one of Mackay’s descriptions of the high prices paid for tu- lips during the mania.
g z g E 2 8
2 6 E
BACKTRACKING THE LEGEND
It is useful to investigate from which sources Mackay constructed our traditional version of the speculation. Mackay provides few references, but at one point he cites Beckmann [1846], from whom it turns out he actually plagiarized most of his descrip- tion. Beckmann carefully cited his sources of infor- mation about the functioning of the markets and bulb sales prices. Beckmann read the dialogues between Wuermondt and Gae~goedt’~ [Anonymous, 16371 and Munting’s [1672, 16961 discussions of this episode.
“Wuerrnondt and Guergoedt” is a series of three pamphlets in dialogue form that provides details about the markets and numerous prices of various bulbs, taken mostly from the final day of the specu- lation. All the price data described in Munting can be
The
Jou
rnal
of
Port
folio
Man
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ent 1
989.
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on
05/0
9/15
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is il
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ed c
opie
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ized
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to p
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lect
roni
cally
with
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her
perm
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The
Jou
rnal
of
Port
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Man
agem
ent 1
989.
16.1
:53-
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tulipmania was confined to a two- to three-week pe- riod in 1637 and to trades in the futures markets for common bulbs that established themselves in taverns in the winter of 163&1637. This bizarre activity was confined to common people who had little net worth but who, nevertheless, made the analogue of ”million dollar bets” with each other. Such bets were unen- forceable in the courts. The image of this event that we have inherited originated exclusively from groups opposed to it, whose objective was to channel eco- nomic activity into spheres that they controlled.
As the now-existing organized futures markets and their customers have their own protectors, with equal access to public opinion, the image that we have of the Crash of 1987 is more equivocal. Yet, those organizations associated with the “safer” spot market in stocks pin much of the blame on the more “spec- ulative” futures markets. Thus, the SEC report [1988, p. xiii] claims that the existence of particular trading strategies involving the futures markets accelerated and exacerbated the declines in prices. Such strategies generate ”negative market psychology,” causing high spreads and price volatility and increased velocity and concentration of stock trading. This leads to greater ”risks incurred by stock specialists” (p. xiv).
The SEC report proposes to equalize margins in futures markets to those in stock markets because “low margins contribute to increased speculative trading that, in normal market conditions, contributes to the illusion of almost unlimited liquidity” (p. xv). It recommends providing for physical settlement of stock in futures contracts to increase the risk that a participant must liquidate his position. It also pro- poses price limits and trading halts. Finally, it pro- poses short-sale restrictions because “the absence of short sale restrictions in the derivative markets, cou- pled with the greater leverage of futures, presents the potential for greater speculative selling than could occur in the stock market” (p. xvi).
From the historical perspective of the tulip- mania, we should not be surprised that all these re- strictions would have t h e effect of channel ing speculative activity into the ”safer area” of the stock market.
I paraphrase this distinction from Schama [1987], p. 343.
* Mackay’s first edition appeared in 1841. The tulip spread into Western Europe from Turkey only in the middle of the sixteenth century. It was accepted immediately by the wealthy as beautiful and rare, appropriate for the most styl- ish gardens. The Dutch dominated the market for tulips, initiating the development of methods to create new flower varieties. The bulbs that commanded high prices produced unique, beautifully patterned flowers; common tulips were sold at much lower prices.
3After the October 19, 1987, stock market crash, the Wall
Street Journal (December 11, 1987) evoked tulipmania. The Economist (October 24, 1987) explained the event as follows:
The crash suffered by the world’s stockmarkets has provided a beginning and middle for a new chapter up- dating Charles Mackay’s 1841 book “Extraordinary Pop- ular Delusions and the Madness of Crowds” which chronicled Dutch tulip bulbs, the South Sea bubble . . . It was the madness of crowds that sent the bull market ever upward. . . . It is mob psychology that has now sent investors so rapidly for the exits (p. 75).
A purchase between September and June was necessarily a contract for future delivery.
Buyers were required to pay sellers one-half stuiver (1 stuiver = %O guilder) out of each contracted guilder, up to a maximum of three guilders for each deal, for ”wine money.” To the extent that a trader ran a balanced book over any length of time, these payments would cancel out.
All discussions of tulipmania openly criticize the activity of buying or selling for future delivery without current pos- session of the commodity sold or an intention to effect de- livery. They attack futures markets as a means of creating artificial risk and do not consider their role in marketing existing risks.
Much of the information here is reconstructed from the discussions in Posthumus [1929] and Krelage [1942, 19461.
‘ I have developed much of the following information in greater detail in Garber [1989].
The 3.5% suggested settlement does not imply a fall in market prices of 96.5% from peak. As all contracts were legally suspect, buyers had little incentive to settle at any price. Even a slight permanent price decline might have triggered massive defaults.
lo This was a return to the pre-1634 situation. Prior to 1634 only a handful of prices are available from recorded sales contracts.
The plague had marched westward with the dynamics of the armies in Germany starting in 1630. See Prinzing [1916] on the epidemics of the Thirty Years War.
New flower bulb varieties can still carry high prices. Infor- mation provided by officials at the Bloembollencentrum in Haarlem indicates that new varieties of “very special” tulip bulbs currently sell for about 5,000 guilders ($2,400 at 1987 exchange rates) per kilo. A small quantity of prototype lily bulbs recently was sold for 1 million guilders ($480,000 at 1987 exchange rates), an amount that would still buy a modest house in some places. Such bulbs, after rapid re- production, ultimately would be marketed at relatively low prices.
l3 These names mean “True Mouth’ and “Greedy Goods.”
l4 The discussion in this section is based on Schama [1987, pp. 323-3711 and on the translation of Penso de la Vega [1688, pp. xii-xix].
l5 The East India Company was enormously successful, earn- ing large profits for its shareholders. The West India Com- pany, more an instrument in the military contest with Spain and Portugal, performed poorly.
[ 1942, 19461. l6 For a list of these pamphlets, see the references in Krelage
The
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The
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Man
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