We have seen recently that a sudden change from excess demand to excess supply is devastating to the economy. The effects of overpayment for commodities resulted in the recent economic woes, the tech bubble a few years back and the disastrous economic events of 1929. The bursting of economic bubbles goes way further back than we realize as shown by the events below.
Prices skyrocketed as demand for a future product soared (demand was inelastic in economic ‘speak’). The product was Tulips and the momentum of demand was like a huge tidal wave growing exponentially. Contracts were taken out for future crops of various derivatives of the beautiful Tulip flowers and bulbs.
Tulips, it is known, are not fast growers; it takes over seven years to grow flowering plants from bulbs or seeds however the rarest tulip, the multicoloured variety, only grows from a bulb. The multicoloured Tulip therefore was highly sought after, far more than it’s red, yellow and other single colored namesakes.
Demand Goes Crazy
The escalating prices were as a result of classic supply and demand economics. Supply was fixed due to the extensive time needed to grow the product whilst demand grew due to fortunes being made. The fortunes were made mostly because of the speculative nature of the future contracts. Tulips, the product, are seasonal and were only physically available for ownership transfer for a few short months each year. Because demand was high, and rising, the contracts could be sold for a higher price than the purchase price of the product itself. The contracts were eventually a product of their own accord and were traded and priced in line with booming demand.
Economic History Repeated
As we have seen recently, when demand is affected or finance becomes scarce, the market collapses. This is exactly what occurred in the Tulip market; very quickly demand plummeted and holders of the contracts for the Tulips were unable to sell the contracts which they had purchased for way more than the product was worth. The economic impacts were devastating and widespread.
The above events occurred four centuries ago, in February 1637 to be exact. The event became known as ‘Tulip Mania’ and resulted in the near collapse of the Dutch economy, where Tulip Mania began.
Isn’t it odd that we are still surprised when excessive speculation results in collapsed economies! Excessive overpayment and trading in overpriced products is called a bubble. Bubbles burst!