Economic history
Was tulipmania irrational?

Tulipmania was not just crazy speculation

Free exchange

IN THE 1630s a sailor was thrown in a Dutch jail for eating what he thought was an onion. That onion was in fact a tulip bulb. The cost of the sailor’s gluttony was equivalent to the cost of feeding an entire crew for twelve months.

That story is probably not true—no sane person would leave something so valuable for an absent-minded seaman to chew on. But like much about tulipmania, the line between fact and fiction is blurred.

“Tulpenwoede” (tulip madness) resulted in big increases in tulip prices. At the beginning of 1637, some tulip contracts reached a level about 20 times the level of three months earlier. A particularly rare tulip, Semper Augustus, was priced at around 1,000 guilders in the 1620s. But just before the crash, it was valued at 5,500 guilders per bulb—roughly the cost of luxurious house in Amsterdam. Prices collapsed in February 1637—although data here are particularly poor—and a few investors were left bankrupt.

The price swings were not caused by massive changes to production costs. Nor did tulips suddenly become particularly useful. As a result, most people assume that tulipmania was the result of financial market irrationality. That idea was popularised by Charles Mackay, a mid-19thcentury Scottish writer. Most modern-day references to tulipmania draw on Mackay’s work. But economic historians provide better explanations for what happened.

Peter Garber blames the general public for the price increases. He reckons that an outbreak of bubonic plague in Amsterdam made people less risk-averse. Dutch city-dwellers knew that each day could be their last—so did not mind indulging in a little speculation. And because gambling was illegal, contracts were unenforceable. If traders misjudged the market, they could just run off without paying.

But on the whole, Mr Garber reckons that investors acted rationally. He suggests that the trend towards extremely high prices, followed by rapid declines, was typical for rare bulbs, due to their growing cycle. And according to Nicolaas Posthumus, a Dutch historian, serious tulip financiers generally did not participate in the speculative markets. Any “mania” was pretty self-contained, and was pushed forward by casual traders, drunk on jenever and moral hazard. Only in the month before the crash does Mr Garber find evidence of speculation from more serious traders.

Earl Thompson, formerly of UCLA, takes a different approach. He reckons that the market for tulips was an efficient response to changing financial regulation—in particular, the anticipated government conversion of futures contracts into options contracts. This ruse was dreamt up by government officials, who themselves were keen to make a quick buck from the tulip trade.

In plain English, investors who had bought the right to buy tulips in the future were no longer obliged to buy them. If the market price was not high enough for investors’ liking, they could pay a small fine and cancel the contract. The balance between risk and reward in the tulip market was skewed massively in investors’ favour. The inevitable result was a huge increase in tulip options prices (see below right). (The price of options collapsed when the government saw sense and cancelled the contracts.) Spot prices (the price that traders paid for immediate delivery of tulips) and futures prices (the prices that traders would be compelled to pay for future delivery of tulips) were not volatile. And any movement of the spot/futures price was determined by simple supply and demand—the fall-out from the Thirty Years’ War, one of the bloodiest in European history, was one important factor.

Thompson argued that popular interpretations of tulipmania have failed to distinguish between options and futures. Tulipmania was only a contractual artifact. There was no “mania” at all.

It is easy to claim that bubbles are irrational. They seem to represent a deviation of prices from fundamental values—and they contradict basic economic theory. But there has been little attempt to understand how speculation actually works. The example of tulipmania shows the importance of doing that—rather than relying on lazy quips about “animal spirits” or irrationality.

Suggested reading list:

Day, C. (2004). ‘Is There a Tulip in Your Future?: Ruminations on Tulip Mania and the Innovative Dutch Futures Markets’. Journal des Economistes et des Etudes Humaines, 14(2), 151-170. [Good background to the tulipmania]

Garber, P. M. (1989). ‘Tulipmania’. Journal of Political Economy, 535-560. [Argues that tulipmania was not irrational in rare bulb trade—though confesses that the price changes to common bulbs does “defy explanation”]

Mackay, C. (2004) [1841] Extraordinary popular delusions and the madness of crowds. Barnes & Noble. [Mackay only devotes about 7 pages to the tulip mania—but his account informs most contemporary perceptions of the event]

Thompson, E. A. (2007). “The tulipmania: Fact or artifact?Public Choice, 130(1-2), 99-114. [A densely-written but precise account of what happened in tulip markets]

Reuse this contentThe Trust Project