Sunday, July 29, 2007

Crashtastic!

The Tulip-Bulb Craze

When: 1634-1637

Where: Holland

The amount the market declined from peak to bottom: This number is difficult to calculate, but, we can tell you that at the peak of the market, a person could trade a single tulip for an entire estate, and, at the bottom, one tulip was the price of a common onion.

Synopsis: In 1593 tulips were brought from Turkey and introduced to the Dutch. The novelty of the new flower made it widely sought after and therefore fairly pricey. After a time, the tulips contracted a non-fatal virus known as mosaic, which didn’t kill the tulip population but altered them causing "flames" of color to appear upon the petals. The color patterns came in a wide variety, increasing the rarity of an already unique flower. Thus, tulips, which were already selling at a premium, began to rise in price according to how their virus alterations were valued, or desired. Everyone began to deal in bulbs, essentially speculating on the tulip market, which
was believed to have no limits.

The true bulb buyers (the garden centers of the past) began to fill up inventories for the growing season, depleting the supply further and increasing scarcity and demand. Soon, prices were rising so fast and high that people were trading their land, life savings, and anything else they could liquidate to get more tulip bulbs.

Many Dutch persisted in believing they would sell their horde to hapless and unenlightened foreigners, thereby reaping enormous profits. Somehow, the originally overpriced tulips enjoyed a twenty-fold increase in value--in one month! Needless to say, the prices were not an accurate reflection of the value of a tulip bulb. As it happens in many speculative bubbles, some prudent people decided to sell and crystallize their profits. A domino effect of progressively lower and lower prices took place as everyone tried to sell while not many were buying. The price began to dive, causing people to panic and sell regardless of losses.

Dealers refused to honor contracts and people began to realize they traded their homes for a piece of greenery; panic and pandemonium were prevalent throughout the land. The government attempted to step in and halt the crash by offering to honor contracts at 10% of the face value, but then the market plunged even lower, making such restitution impossible. No one emerged unscathed from the crash. Even the people who had locked-in their profit by getting out early suffered under the following depression.

The effects of the tulip craze left the Dutch very hesitant about speculative investments for quite some time. Investors now can know that it is better to stop and smell the flowers than to stake your future upon one.

Check out other crashes at http://www.investopedia.com/features/crashes/

What Have We Learned?
As hindsight is always 20/20, we should take the time to highlight what we can learn
from these past tragedies. First off, we should point out that most market volatility is all our fault. In reality, people create most of the risk in the market place by inflating stock prices beyond the value of the underlying company. When stocks are flying through the stratosphere like rockets, it is usually a sign of a bubble. That’s not to say that stocks cannot legitimately enjoy a huge leap in value, but this leap should be justified by the prospects of the underlying companies, not just by a mass of investors following each other. The unreasonable belief in the possibility of getting rich quick is the primary reason people get burned by market crashes.

Remember that if you put your money into investments that have a high potential for returns,
you must also be willing to bear a high chance of losing it all. Another observation we should make is that regardless of our measures to correct the problems, the time between crashes has decreased. We had centuries between fiascos, then decades, then years. We cannot say whether this foretells anything dire for the future, but the best thing you can do is keep yourself educated, informed, and well-practiced in doing research.

9 comments:

mohican said...

Recently, worldwide real estate has gone through some similar, although numerically more subdued, phases. Combine a relatively short supply of a desired commodity (housing) and add in speculation with rampant silly arguments. Throw in some government intervention and voila - bubblicious.

freako said...

But you can't live in a bulb!

Access said...

Is it a worldwide real estate phenomenon or is it a phenomenon resticted to the anglo nations and some nations impacted by the escalation of real estate prices in the anglo nations - Spain, parts of France, and parts of Mexico? Friends in Sweden, Austria, and Germany do report the same type of run up on real estate - yes it it expensive but it always has been - other thoughts?

patriotz said...

Problem is the anglo nations have such a large % of world income and available credit that they have the means to export the RE bubble just about anywhere.

The flip side of this IMHO is that the unfolding RE crash in the US will destroy so much liquidity it will bring down the RE bubble worldwide. The reason BTW why the bubble popped first in the US is that it has the most elastic supply. But the bubble is doomed everywhere anyway, as they always are.

jesse said...

"But you can't live in a bulb!"

And judging from the number of dark condo windows, I suppose this is somewhat true for condos as well. To be fair, you can eat a tulip bulb, so its intrinsic value during times of depression is not exactly zero.

freako said...

To be fair, you can eat a tulip bulb, so its intrinsic value during times of depression is not exactly zero.

You've probably read the story about the poor sailor who mistakenly ate a tulip bulb and was promptly jailed.

RentingSucks said...

So I'm thinking. Everyone now seems to thinkt he stock market is overvalued and is going to come down. Does this mean I should buy stocks in bucket loads because it is about to do 20 percent a year for the next 5 years?

Just thinking.

freako said...

"So I'm thinking. Everyone now seems to thinkt he stock market is overvalued and is going to come down. Does this mean I should buy stocks in bucket loads because it is about to do 20 percent a year for the next 5 years?
"

No, because if everyone thought the stock market was overvalued, valuations wouldn't be where they are now.

Don't confuse contrarian murmurings with a total change in market sentiment.

mohican said...

If only the Dutch figured out that all they needed to do was add some hardwood flooring and granite countertops they would have doubled the value of those tulips overnight!