Business Math in Action

Tulips Too Good To Be True

Investing in stocks always involves some risk, so it makes sense to research a company before you buy shares of its stock. Invest prudently, and you should see a decent return on your investment. Some people, however, view the stock market as a kind of lottery-if only you could figure out what the next Starbucks, Amazon.com, or Microsoft was going to be, you could buy the stock and strike it rich. When a lot of people decide that a certain company is the next big thing, it can drive the price of that stock up so high that it doesn’t reflect what the company is actually worth. That’s called a bubble. Unfortunately, what goes up usually comes down-hard and fast-leaving a lot of investors broke. That’s called a crash. While Starbucks, Microsoft, and other legendary companies did make early stockholders very wealthy, those instances are rare.

The most astonishing stock bubble of all time took place more than three centuries ago and involved a simple flower. In 1593, tulips were first brought to Holland from Turkey. They soon became very popular collector’s items among the upper classes. At that point tulips were pricey, but no more so than other diversions beloved by the rich. After a few years, tulips that were cultivated by the Dutch contracted a virus that caused their petals to “flame,” or turn multicolored. The flames made tulips even more expensive, depending on the rarity of the colors. The fact that the cultivated tulips were less hardy than the originals made them seem even more rare and valuable.

In 1634, tulip prices began to soar to unreasonable heights. The Dutch were convinced that other Europeans would love tulips as much as they did, and that the price of the flowers would never decline. In fact, there was a wave of “tulipmania” in England and France, but it never reached the level it did in Holland. According to historian Charles Mackay, “The ordinary industry of the country was neglected, and the population, even to its lowest dregs, embarked in the tulip trade . . . People of all grades converted their property into cash, and invested it in flowers. Houses and lands were offered for sale at ruinously low prices, or assigned in payment of bargains made at the tulip-mart.”

In 1637 a few shrewd souls-mostly upper-class investors who had some understanding of how markets rise and fall-realized that the price of tulips couldn’t escalate forever. They decided to hold on to their money and stop buying and selling tulips. Prices began to fall immediately, and panic struck. People who had agreed to buy bulbs at a particular price now declined to go through with the deal. The Dutch courts refused to intervene, stating that bulb-trading was nothing more than gambling. People who sold at the beginning of the crash managed to salvage their assets, but those caught holding the bulbs were ruined. The nation as a whole suffered tremendously because so many citizens lost not only their savings but also their homes and businesses.

The Dutch never forgot the lessons of tulipmania, yet their love for tulips was clearly genuine. Today, tulip production contributes more than $750 million to the Dutch economy, and over three billion tulip bulbs are produced every year.