Written By Xavier Wallin

In recent years the speculator lies at the forefront of financial and economic discussion – currency crises, derivatives fiascos, stock market bubbles or crashes in the housing market all stem from the subject of speculation. This slippery business can sometimes be heavily rewarding as described by renowned economist Adam Smith who commented in The Wealth of Nations how precipitous fortunes are “sometimes made by what is called the trade of speculation”. However, it is important to remember the double edge nature of speculation which incorporates much risk and results in as frequent losses as gains. American businessman and investor Charlie Munger commented on the dangers of speculation for individuals saying, “We have a stock market which some people use like a gambling parlour.”

What is Speculation?

In Finance, Speculation can be defined as conducting a financial transaction involving high risk with the expectation of potential significant gain in value in the future. As a result, speculators often disregard the intrinsic value of a security and instead focus their attention on price fluctuations, particularly of volatile markets. In this way, unlike hedgers who attempt to offset pre-existing risk or investors who take on much less risk through long term ownership of securities, speculators can be simply described as taking on huge risk for a chance of huge returns. This clear distinction between investment and speculation is no new concept. During the 18th century Adam Smith defined the speculator’s investments as “fluid” whereas those “of the conventional businessman” as “fixed” and John M. Keynes compared in the early 20th century “Enterprise – the activity of forecasting the prospective yield of assets over their whole life” to speculation – “the activity of forecasting the psychology of the market”.

Tulip Mania

One danger of speculation is that it can lead to a speculative bubble, a phenomenon in which the price of an assets greatly deviates from its intrinsic values. Some of the earliest economic bubbles can be traced back to ancient times such as speculation of the Roman public Stock market (“Publicani”) – however due to lack of evidence surrounding the topic, it is difficult to be studied in much depth. Hence, the Dutch Tulip Mania bubble has broadly been considered the first recorded speculative or asset bubble.

During the 1630’s, the Dutch Republic would experience a golden age. Thriving conditions and the Netherlands being at the centre of global trade would set the scene for an outburst of speculative euphoria. The Dutch have always had a strong affection for flowers – perhaps due to Holland’s flat terrain and rich soil (perfect for bulbs) but this alone does not explain what would happen in 1636. In the middle of the 16th century, the first tulip bulbs were introduced to Europe from the Ottoman empire by Ogier de Busbecq, the imperial ambassador to Suleiman the Magnificent. Initially the flowers were reserved for the elite and spread to the Netherlands when the ambassador presented some tulips to botanist Carolus Clusius who distributed them for enormous prices. Shortly after was a surge in popularity for the tulip – its intense saturated colour made it stand out from other flowers, leaving it as a status symbol of the time. This coupled with reduced Calvinist austerity and the Dutch people enjoying the highest incomes in Europe was certain to create a frenzy of demand for the exotic flowers.

Speculation of Tulips

However, the speculative period known as Tulpenwoerde (Dutch) or Tulipomania (Victorian English) didn’t start until “outsiders”, or “new amateurs” entered the market in 1634. Attracted by stories of soaring prices for Tulips, foreign speculators were willing to pay higher and higher prices for bulbs, expecting prices to keep on rising. And they did – for a while. To put into context the exorbitant prices tulips were bought for, the average wage in the Netherlands was 200-400 guilders and a small-town house cost 300 guilders. In comparison, at the height of the bubble the Semper Augustus (most prized bulb) would sell for 6000 guilders, 20 times the average wage or house price. Even less popular bulbs such as Generalissimos sold for 900 guilders. However, the market was not stable. Wealthy bulb collectors who had initially shown a readiness to pay vast sums for rare bulbs, withdrew from the market as prices became extortionate. Additionally other wealthy individuals who could actually afford the bulbs such as Amsterdam merchants chose not to invest their trading profits into tulips, which to them was simply an expression of wealth, rather than a speculative asset. Without these two parties, the tulip bulb market lacked any sort of stability. At the height of the euphoria, no tulip delivery occurred in 1636 – this resulted in the formation of a tulip futures market in which speculators would trade futures contracts to purchase tulips at the end of the year. This would be informally nicknamed Windhandel (wind trade) by the Dutch because no actual tulips were being exchanged. Moreover, at the Inns where trading took place, transactions would not even be expedited with money the flowers but rather with personal credit notes. Nearing the end of the tulip phenomenon, the combination of paper credit with Windhandel acts as a perfect representation for the unsustainable nature of the tulip trade in holland; transactions for tulips that could never be delivered because the flowers didn’t exist, and credit notes could never be honoured because the money didn’t exist.

The crash

In a pamphlet of the time, a speculator of the name Gaergoedt recounted how “if there should ever be more sellers than buyers, then the collapse of this mania will be at hand”. He was right. On 3 February 1637, following rumours in Harlem that there were no more buyers, the tulip market suddenly crashed. All bulb deliveries ceased, and future contracts were unable to be fulfilled as one default followed another. For many, the crash caused a significant loss in wealth; especially for those who had mortgaged their houses or sold their assets to make a quick gain. Moreover, many florists vainly attempted to enforce debt from defaulting speculators. However, the Dutch fortunately economy survived – the tulip bubble crash did not give rise to a national economic crisis. This was because the Dutch economy was dependant on the credit of the great Amsterdam merchants who were largely unaffected by the crash; they had chosen to invest in land and East India Stock rather than bulbs. There was much litigation regarding the former tulip market up until May 1638 when the Dutch government declared tulip contracts could be annulled on payment of 3.5% of the agreed price.

 Tulip price index from 1636-1637. The values of this index were compiled by Earl A. Thompson in Thompson, Earl (2007), “The Tulipmania: Fact or Artifact?”, Public Choice 130, 99–114 (2007).

Tulip Mania vs Cryptocurrency

Since Tulip Mania a range of speculative bubbles have both inflated and popped. These include the Mississippi Bubble (1719-1720), the Japanese Bubble Economy of the 1980’s and the Dotcom bubble in the late 1990s. However, in the 21st century to what extent can we compare Tulip Mania to the state of cryptocurrency. Over the last decade the landscape of cryptocurrency has shown every sign of a speculative bubble; since Bitcoin reached $1 in 2011 it had increased by 6,400,000% when it reached it height in 2021. In this way, bitcoin’s volatile nature makes it clear that behind it lurks the speculator. But why can bitcoin be considered a speculative bubble?

Firstly, similarly to tulips, bitcoin and other cryptocurrencies have greatly deviated from there intrinsic values which to some extent they don’t even have. In response to this, many crypto fanatics turn to fiat currencies – claiming the same point. However, unlike crypto, fiat currencies act as a store of value due to people’s confidence that there bank notes will be accepted anywhere at anytime in the economy.

Additionally, they are heavily monitored by governments to ensure they are stable; preventing volatile price fluctuations and making it difficult for speculation to occur. Unlike fiat, Bitcoin’s volatile nature dismisses its possibility as a medium of exchange and hence serves no real purpose other than speculation (Just like tulips in 1636). Cryptocurrency’s classification as a speculative bubble is also because its price is driven by momentum and attention from individual investors (speculators). As a result of monumental returns bitcoin has soared in popularity attracting ignorant retail “investors” (speculators – not investors) trying to make a quick buck of the latest “get rich quick” scheme – the price of bitcoin is directly related to the “hype” it receives. This is in many ways parallel to the tulip situation in Holland where stories of huge returns attracted new buyers who expected the price to never stop increasing.

The clear symmetry between the two forebodes a negative future for bitcoin – both started as niches, and which grew into public frenzies. In the case of Tulips, the bubble burst, so regarding cryptocurrency – the bubble will implode.

Bibliography:

Chancellor, Edward, Devil Take The Hindmost: A History of Financial Speculation, Plume books, 2000

Thompson, Earl, The Tulipmania: Fact or Artifact?, Public Choice 130, 2007

Smith, Adam, The Wealth of Nations, W. Strahan and T. Cadell, London, 1776

Munger, Charlie, in the 2022 Daily Journal Annual meeting, 2022