What would you pay for a tulip? $3? $5? Maybe $20, but it would have to be very special. Would you believe 400 years ago, some tulips were worth more than a nice house? When ‘Tulip Mania’ took over the Netherlands in the mid 1630s, this really happened.
Historians believe the flower was first introduced from Turkey. Bright and colorful, the tulip was new, and prized because it was scarce.
Suppose that 1,000 people want tulips but only 10 are available, what happens to the price of tulips? Well it goes up, probably a lot! This is called ‘the law of supply and demand’ and it applies to anything which is bought and sold. If you had a tulip in the Netherlands in 1635, you could make a lot of money. The demand for tulips at that time was much higher than supply so the price just kept shooting up.
How could this happen for a simple flower? Well, if everyone expects the price of something to keep going up then you can make money just by holding on to it. In fact, you can even make money by agreeing to sell something in the future, even before it exists. This is called a ‘futures market’.
Here’s how it worked back in 1600s Netherlands: Imagine you begin to grow a tulip bulb in 1636, the height of Tulip Mania. When it blooms in 12 months, it’s going to be worth a lot of money. Just then, your friend Jenny visits and says, “Hey, I’ll pay you $100 right now for that flower and when it blooms next year it’s mine.” You sign a Contract and the deal is done. You get cash now for a flower that doesn’t exist yet and you don’t have to worry about selling it later. Of course, if the tulip doesn’t bloom at all you have to give back the $100.
But Jenny didn’t really want the tulip for herself, even though it will be very pretty. Wait, what? Why did Jenny buy it if she didn’t want it? Jenny is betting that the price of the flower in one year will be much more than $100, and she will make a profit. However, it gets even weirder! Because Jenny paid $100 for a tulip ‘Contract’ (remember the tulip doesn’t even exist yet) then she can sell the Contract to Zoe who is willing to pay $200 for it because she bets it will be worth even more money in the future.
Zoe now has two choices. She can either keep the Contract and collect your tulip when grown or she can sell the Contract and try to make even more money, just like Jenny did. Zoe decides to sell to another buyer, and that buyer will sell to another buyer. Every time the Contract is sold, the price for the ‘future’ flower increases. The word for all this buying and selling is ‘speculation.’ Every buyer is speculating about what the future price will be when the tulip blooms.
It’s February 1637, and your tulip is now fully grown. Whoever holds the Contract is now the proud owner of your tulip. Who will show up at your door? Not Jenny, not Zoe, but somebody you never heard of called David. He was at the end of a long line of buyers and he paid – wait for it! – $250,000! That’s an incredible amount of money and all of the buyers along the way have made a nice profit on selling the Contract. The question now is – “how much is the tulip really worth today?” You can be sure that David is really nervous! He could make a lot of money if the price has gone up even more or lose a fortune if his guess was wrong.
Well, the bad news for David is that the price of tulips dropped fast in early 1637. His lovely tulip is now worth only a few hundred dollars – he is ruined! This really happened in the Netherlands in 1637 and this is the first example in history of what is known as an ‘economic bubble’ – a period when everyone thinks the value of something will keep going up and up…. until the bubble pops and the price comes crashing down.
No wonder it was called ‘Tulip Mania!’ But don’t get the idea this is something historical. Bubbles have happened several time in recent years…it can happen with basically anything that can be bought and sold.