While in Amsterdam last week, I visited the Tulip Museum on a whim. It was small, but informative. Before leaving, I bought a book called Tulipomania, less because I’m riveted by tulips than because I was out of reading material and Dutch bookstores were closed for Easter Monday.
The book, by an historian named Mike Dash, turned out to be quite good. It gave a much more nuanced explanation of the Dutch tulip mania of the 1630s than the usual cautionary tale.
For those completely unfamiliar, the Dutch Tulip Mania was a meteoric rise in the price of tulip bulbs in the Netherlands in the 1630s, followed by an equally dramatic crash. Tulip mania is a handy metaphor for the madness of crowds that creates boom-bust cycles, whether it’s the 1929 stock market crash or, more recently, the housing bubble that burst and precipitated the Great Recession of 2008-2009.
Dash explains several conditions that contributed to the mania that most accounts gloss over, and I was struck by how many of them remain relevant to understanding—and avoiding—today’s bubbles.
One of Dash’s eye-opening points is that, unlikely as it seems to us today, the tulip mania occurred in an environment of extreme scarcity. Though it’s true that the prices paid for many bulbs were simply outrageous, for the top specimens, they were somewhat justified by extreme rarity. Though tulips are fairly ubiquitous today—you can go to your local greenhouse or Home Depot and buy practically as many as you want—they haven’t always been so.
Tulips are actually native to central Asia—in particular, the inhospitable mountains where western China meets Afghanistan and Russia. And while they had been popular among the Persians and Ottomans since at least 1050, evidence suggests tulips didn’t reach the Netherlands until 1570.
Sixty years later, at the time of the tulip mania, tulips were still fairly rare in Holland. Compounding their scarcity was the fact that the Dutch preferred a specific kind of tulip hybrid, with a long stem and smooth, rounded petals, that was distinct from both wild tulips and the flowers cultivated in the East (which had almond-shaped petals that tapered to a needle-like point).
Despite their popularity, these cultivars (as garden-bred hybrid tulips are called) remained scarce for a long time thanks to the tulip’s reserved reproduction habits. Tulips, you might say, do not multiply like rabbits. On the contrary, it takes six or seven years for a tulip seed to grow to a flowering bulb. Furthermore, the flower eventually produced by a seed can vary greatly in appearance from the flower from which it was collected.
Luckily, mature flowering tulip bulbs also reproduce by producing so-called offsets, tiny baby bulbs that sprout off the mother bulb. Offsets can be removed and planted themselves, and will grow to mature flowering age in only a year or two. Plus, offsets resemble their mother exactly (with one notable exception we’ll cover in a second).
The one drawback of propagating tulips by using offsets is that most bulbs produce only two or three offsets a year. Because offsets only grow off mature bulbs, you can only harvest offsets for a few years before the mother bulb dies.
Because of the severely constrained quantity of desirable bulbs, Dutch growers of the 16th and 17th centuries, couldn’t quickly produce gardens full of tulips. A grower who created a particularly attractive new hybrid wouldn’t be able to grow even one more for another year or two. Growing more than a handful of the new variety could take a decade, especially if the grower sold or shared a bulb or two along the way.
Knowing this, it becomes clearer why the most-prized bulbs sold for many times the value of a house at the height of the mania. They were, literally, more rare than gold or diamonds.
There was one final biological factor contributing to tulips’ scarcity—or at least the scarcity of the most-prized specimens. In addition to long stems and round, smooth petals, the Dutch highly prized tulips with vibrantly colored flames on the petals. The most preferred varieties had thin, delicate, but brightly-colored red or purple flames on otherwise entirely white petals.
Unfortunately for the Dutch, these so-called “broken” tulips were impossible to reproduce reliably. A bulb that had produced a solid flower one year could break the next, and while flowers from that bulb would be broken from then on, their seeds, and, less frequently, the bulb’s offsets, could still produce less-valuable solid-colored flowers. No one knew how or why tulips broke, nor could they induce them to do so.
In fact, it wasn’t until the 20th century that the mystery of breaking was solved: As it turns out, the beautiful flames and the vibrant colors were caused by a virus. The virus also made the bulbs smaller and weaker, contributing to their scarcity, although that was also unknown at the time.
Of course, scarcity only explains half of the supply and demand situation that was necessary for tulip mania to occur. On the demand side, there are fewer concrete explanations—aesthetics, after all, are highly subjective. However, several cultural conditions contributed to the immense popularity of tulips.
One was the Dutch Puritanism of the time. Elaborate clothes, jewelry and the like were shunned in favor of a simple black uniform. One permitted luxury was a beautiful and even expensive garden, possibly at a beautiful country house. This allowed indulgence made tulips a stand-in for more durable luxury goods. (Commissioning paintings was another acceptable way of showing off one’s wealth, which explains the plethora of quality Dutch artwork from that era.)
Secondly, the Dutch were fastidious savers, and various political and economic factors meant that by the 1630s, many Dutch families, even the solidly middle-class, had accumulated a substantial nest egg. Unfortunately, there were few opportunities for ordinary people to invest their money in 17th century Holland. Banks in the modern sense were unknown, and while Amsterdam did boast the world’s first stock exchange, investments there and in most other opportunities required large amounts of capital. Buying a share in a shipping expedition was one option in reach of savers of more moderate means, but the great distance of foreign ports meant those investments took years to pay off, limiting their popularity. (Though the investments of the wealthy in the shipping trade, and their outstanding returns, were one of the primary drivers of Dutch prosperity.)
Tulip bulbs, on the other hand, were an investment that even an ordinary Dutchman could afford.
And they seemed like a smart investment too, for the usual reason: prices just kept going up. As the mania approached its climax in 1636, a single tulip bulb fetched the incredible price of 6,000 Dutch florins, or about $22,000 in today’s money.
Sound familiar? While Dash’s book was published in 1999, well before all of our most recent bubbles popped, the similarities to the housing bubble—and subsequent crash—are eerie.
In addition to tulip bulbs’ affordability, there’s the promise they held of upward mobility. As Dash writes:
“The United Provinces [then the name of the Netherlands] possessed, however, one vital national characteristic in greater measure than any other nation in Europe in the first half of the seventeenth century. This was the belief in the possibility of social mobility that was the birthright of every Dutchman. In France or the Holy Roman Empire, a peasant knew that whatever happened to him, he would always remain a peasant, just as a shopkeeper would be the son and the father of shopkeepers. But the United Provinces was a land where an immigrant’s son had become the wealthiest man in the richest city on earth ... and where a moderately well-off artisan could and occasionally did invest his money by taking a minute share in a ship setting off to trade in the Baltic, reinvest the profits and work his way up until he himself became a shipowner.”
I don’t need to tell you that the potential for social mobility is a powerful human motivator. In Holland in the 17th century, it fueled immense demand for affordable and high-potential investments, and flower bulbs fit the bill. In the U.S. in the 21st century, we call it The American Dream, and it fueled unprecedented—and government-sanctioned—demand for houses.
In both cases, the culture of social mobility that fueled demand had one major, and eventually fatal, side effect. After years and years of consistently rising prices, whether for bulbs or houses, people can begin to believe that it is impossible for prices to do anything but go up. As (I hope) we have learned by now, that’s never true. But during the window of years or months where the myth of ever-rising prices becomes conventional wisdom, very dangerous deals can be done, especially in a culture where anything is possible. In the U.S. in the last few decades, those deals became known as sub-prime mortgages. In the Netherlands in the seventeenth century, much the same thing happened when it became acceptable to buy tulip bulbs while they were still in the ground. From Dash:
“A florist with a capital of only 50 guilders who was certain prices would continue to rise might, for instance, throw caution to the wind and agree to purchase five of the 100-guilder Goudas. His money would be enough to pay a deposit of 10% on each bulb, and if by lifting time [the summer, when bulbs could be dug up and collected] the price of bulbs had doubled, his 50 guilders would have made him the owner of 1,000 guilders-worth of bulbs. After selling the flowers at the new and higher price, he could pay the balance of his obligation and walk away with a clear profit of 500 guilders. Thus, if the trade remained buoyant, poor artisans could indeed hope to make huge fortunes from flower bulbs. But should the price of tulips fall, catastrophe was certain and bankruptcy all but inevitable. If Goudas halved in value, for example, the florist who had invested his entire savings of 50 guilders in bulbs would be facing a loss of 200 guilders—a sum he could not possibly hope to pay.”
Again, sounds familiar. Too bad more bankers didn’t read this book in 1999.
But if the conditions that led to the mania sound familiar, the events that led to the eventual crash are practically identical to those of a few years ago.
First, we have a large and growing number of everyday citizens, not experienced investors, participating in a market for rapidly appreciating goods and buying on razor thin margins, in the expectation that prices will continue rising forever.
Second, both bubbles, and crashes, depended on the introduction of new and complex financial instruments. Obviously, the adjustable-rate sub-prime mortgages and related derivatives used in the U.S. in the 21st century were a lot more complex than the instruments used by Dutch tulip traders in the 17th century. But in an age before modern banks, buying bulbs that couldn’t be collected for months with a small deposit was exotic. And by the height of the mania, tulip bulbs were changing owners multiple times between being planted in the fall and being lifted in the summer—with each owner owing the previous owner more money. It was a financial daisy chain admittedly simpler than, but not entirely unlike the ones we created by packaging sub-prime mortgages into mortgage-backed securities and collateralized debt obligations.
Finally, both bubbles eventually popped when prices rose so high, so fast that they outpaced even the feverish bubble-fueled demand. In the U.S. housing market, skyrocketing prices coupled with demographic trends meant that by 2006, there simply weren’t enough buyers to support prevailing home prices. In Holland in late 1636 and early 1637, a similar situation was shaping up:
“The absence of cheap bulbs meant, in turn, that it was all but impossible for more novice florists to enter the market, for who could afford to do so if the very cheapest lots were selling for dozens or even hundreds of guilders? A handful of the existing traders were even selling up and trying to take their profits, so a shrinking group of florists, possessed of only a limited amount of capital, was somehow sustaining a constant rapid rise in prices. Sooner or later, even those who still believed the trade was fundamentally healthy would become unable to afford the next price rise and hesitate to commit themselves. Thus, by the beginning of February [1637], money and bulbs—the twin fuels of the flower mania—were both exhausted. And like a sun which has burned the last of its fuel, the tulip mania ‘went supernova’ in a final, frenzied burst of trading before collapsing in on itself.”
And, like in the U.S. in 2007 and 2008, once prices fell and the market crashed, those complex financial instruments became buyers’ worst enemies:
“Practically every trader was now faced with a situation where he had put down deposits on tulips which were now worthless, and would be expected to pay substantial additional sums to complete his purchases when the bulbs were lifted in only a few months’ time. Many had little choice but to default.”
Cleaning up the mess caused by the tulip market crash took years—many local governments passed laws banning tulip-trading cases from the courts, preferring to let the parties fight it out among themselves. After prices collapsed, lawsuits broke out all over Holland as sellers tried to enforce their tulip-futures contracts. However, judges decided that the contracts were gambling debts, and hence unenforceable by law. In Haarlem, center of the tulip trade, the city’s leaders declared that buyers could absolve their debts by paying sellers 3.5% of the agreed price. Nevertheless, it took years for the last tulip cases to clear, and while the Dutch economy was not derailed (contrary to some beliefs) many lives were ruined for much longer.
If you’ve stuck with me this long, it’s time for your reward. Today’s Investment of the Week is a value stock, so no bubble risk here. It was recommended by Stephen Leeb, editor of The Complete Investor, in his April issue, and then we featured it in the May 4 Dick Davis Investment Digest. Leeb wrote:
“Madison Square Garden (MSG) [was] spun off a little more than a year ago from Cablevision Systems. It owns and operates Madison Square Garden, the Chicago Theater, the Beacon Theatre, the New York Knicks, the New York Rangers, the New York Liberty, the Radio City Christmas production, MSG Sports Networks, Fuse Networks and more. These assets are so unique that it’s hard to ascertain their true value. However, on a purely accounting basis, the shares are trading at a mere 1.8 times book value—a low valuation indeed. If the assets are undervalued, as we suspect, the shares present an even bigger bargain. This fully integrated sports, entertainment, and media company operates via three segments: MSG Sports, MSG Entertainment, and MSG Media. They’re strategically aligned to work together to drive the company’s overall business, which is built on a foundation of iconic venues and compelling content. Madison Square Garden is commonly associated with the value of its namesake arena, whose earning power the company hopes to boost via a current renovation (in company parlance, ‘transformation’) and from its sports franchises. But the arena is just part of the company’s appeal and doesn’t factor in the potential of the company’s cable networks and its fully integrated business model, which we think merit a premium valuation. The full value of the company’s unique brands is nowhere near reflected in its low price-to-book valuation, and we’re adding Madison Square Garden to Income/Value Portfolio this issue.”
I don’t know if someone at the company read Leeb’s analysis, but just last week, Madison Square Garden announced that it would be changing its name to The Madison Square Garden Company, to more accurately convey “the full scope and depth of the company, which is a fully-integrated sports, media and entertainment company.” If investors get the message, this will be a great stock to buy and hang on to.
Wishing you success in your investing and beyond,
Chloe Lutts
