Author: Self-Control
Reviewer: Millisecond

  Financial crisis: a specter haunting every country with a market economy. Ever since humanity created financial systems, crises have ranked among the most frightening of events. Each time one appears, countless people can go from immense wealth to utter poverty overnight.

  The Great Depression triggered by the financial crisis of 1929–1932 even helped bring about the Second World War indirectly. Looking closely at the crises in financial history reveals just how many tricks the financial titans of the past employed—and how irrational people could become when profits beckoned.

  We will trace this frightening phenomenon gradually and in chronological order. Today, we begin with the first crisis of the modern financial system: the tulip bubble.

  In the seventeenth century, the Netherlands earned the name “the coachman of the seas” through superb shipbuilding, an excellent reputation, a fearless spirit—even with pirates everywhere, Dutch merchant ships carried no weapons so that they could load more cargo ∑(￣□￣;)—and the backing of a powerful domestic financial system. That sound financial system allowed capital for overseas voyages to be raised from the entire population, while also letting the public share in the enormous returns from maritime trade. In short, seafaring made the Dutch rich.

  People with money, however, are prone to extravagance—especially in the seventeenth century, when capitalism was not yet highly developed and conspicuous consumption was widespread. Rather than reinvesting their earnings in production to make still more money, people bought luxuries to display their wealth. Against this backdrop, the tulip bubble quietly began to swell.

  Tulips are native to Asia Minor and were grown chiefly around what is now Turkey. They began spreading through Europe in the mid-sixteenth century, just as European aristocrats were competing to flaunt their wealth. Tulips quickly became fashionable objects that nobles displayed and exchanged among themselves.

  Tulips became popular in the Netherlands mainly in the seventeenth century. In 1593, Clusius, a professor of botany from Vienna, accepted an invitation from a Dutch university and brought several tulips with him. Their elegant appearance quickly won over the Dutch upper classes. Because tulips were difficult to cultivate and took a long time to bloom, their prices soon rose. Even so, that alone was nowhere near enough to drive the entire Dutch population wild.

  At this point, a group fostered by the Netherlands’ advanced financial system entered the scene. They would reappear in crisis after crisis and remain active today: speculators. They quickly spotted the extraordinary profits tulips promised and began hoarding bulbs to sell when prices rose. This pushed prices higher still. The tulip might as well have declared: “In my long life as a flower, I have learned one thing: a flower’s power has limits. So I reject my flowerhood, Dutchmen!”

  How high did tulip prices climb? In a single year they rose by as much as 5,900 percent—a full 59-fold increase—even though they had already started from a high base. The most expensive variety, Semper Augustus, cost as much as a carriage plus several fine horses. Another force was driving all this: asset securitization. With too few tulips to go around, speculators went straight to the nurseries and signed financial contracts with growers to reserve bulbs that would mature in the future. They then took those contracts to financial exchanges and sold them at higher prices. This was an early prototype of the financial futures contract.

  Because these contracts could be traded, everyone could participate in the tulip market. The enormous returns from seafaring had put money in people’s pockets and shown them the attractions of finance. They threw themselves headlong into the financial bubble forming around tulips. Extraordinary profits drove them to extraordinary madness.

  “Oh, citizens, this is the price of frenzy.”—Rousseau. This was Rousseau’s taunt to the Dutch after the tulip bubble. The bubble was finally pricked by a chance event. A sailor who had been working aboard ship knew nothing of the tulip craze at home. When the ship docked, he casually took a tulip bulb for which the owner had paid three thousand gold coins—a Semper Augustus—mistook it for an onion, and ate it with his fish and other seasonings.

  Furious, the captain took the sailor to court, but the case came to nothing. The incident nevertheless made people reassess what a tulip was worth, like a bucket of cold water thrown over a feverish crowd. A small group began selling their tulip contracts. More people then sensed that something was wrong, and a mass sell-off quickly followed. Tulip prices plummeted; overnight, the bulbs became worthless. Efforts to slow the collapse by buying contracts for even 10 percent of their face value proved futile. At last, the bubble that had grown as everyone talked it up burst.

  Countless families saw their wealth vanish, and some were left with crushing debts. The crisis also sent the Dutch economy into sharp decline and weakened its shipbuilding industry. In the second half of the seventeenth century, England was therefore able to defeat the Netherlands with ease, depriving it of the rewards of seaborne trade.

  The tulip bubble was the first financial crisis of the modern era, and it offered lessons enough. Such crises illustrate many financial theories, including herd behavior and the greater-fool theory. Financial crises will never disappear, because they arise from the human desire for wealth. Before long, we will see the same phenomenon assume a new disguise in France.

Sources

  • Half-Hour Comics on Economics: Financial Crises, Chen Lei and the Half-Hour Comics team
  • “The Tulip Bubble from Beginning to End,” China Urban and Rural Financial News
  • “The Tulip Financial Bubble,” Zhang Ning
  • Images sourced from the internet