What is an economic bubble? Josh and Chuck explain why the Dutch sold everything to invest in tulips during Tulipmania

In the recent episode of the STUFF YOU SHOULD KNOW podcast, host Josh and Chuck talked about a phenomenon called Tulipmania. During the April 3 episode of the podcast, Josh revealed:

“Tulipmania was perhaps the first financial bubble to happen and then burst, and we should probably talk a little bit about what an economic bubble is.”

An economic bubble takes place when current asset values significantly surpass their intrinsic valuation. The valuation is not supported by the underlying long-term fundamentals. Any time a good's price increases significantly above its true value, an economic bubble is created.

The Dutch tulip bulb market bubble is one such example of the market bubbles and crashes in history. During the early to mid-1600s, speculation drove the value of tulip bulbs to extremes in Holland, a phenomenon sometimes known as Tulipmania. At the height of the market, the rarest tulip bulbs were available at six times the typical person's yearly salary.

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Exploring the phenomenon of Tulipmania following Josh and Chuck's discussion during their podcast

When an asset's or a group of assets' price quickly climbs to levels well above their fundamental value before abruptly collapsing, this is known as an economic bubble. This unsustainable price gain is frequently the result of irrational exuberance, excessive market enthusiasm, or speculation, rather than being motivated by the asset's intrinsic value.

Although the exact reason for this shift in investor behaviour is up for debate, bubbles are usually ascribed to it. When the bubble "bursts," prices typically drop precipitously, which can cause financial losses and economic instability. This is similar to what happened to the tulips during Tulipmania in Holland in 1600.

As an early example of a financial bubble, Tulipmania alludes to the speculative frenzy in 17th-century Holland, when tulip bulb prices reached previously unheard-of heights before plummeting.

The 16th century saw the introduction of tulips to Europe through the spice trade, which gave these imported flowers importance. They did not resemble any other natural bloom on the continent.

As per Britannica, the wealthy merchants wanted the tulips as a status symbol. At first, people bought them purely for their price. Soon, the demand for tulip bulbs of various colours outstripped the supply. Prices for individual bulbs of rare variations started to skyrocket throughout northern Europe.

Next came the Tulipmania, which occurred in 1633 when tulip prices in Holland skyrocketed. The value of a single bulb could reach 4,000 or even 5,500 florins. Around 1610, one bulb of a new variety was accepted as a bride's dowry, and one bulb of the Tulipe Brasserie variety was traded for a thriving French brewery.

In Holland, the bubble peaked between 1633 and 1637. The same source informed that in order to purchase bulbs for later resale at higher prices, homes, estates, and businesses were mortgaged. Rare types of bulbs were sold for hundreds of dollars each, and transactions and resales were conducted numerous times without the bulbs ever leaving the ground.

However, the craze subsided after a few years, and by February 1637, prices had started to fall. Prices levelled down by 1638. Meanwhile, during the same podcast, talking about the topic, Chuck stated:

“Tulips first arrived in Holland around 1600. The Dutch East India Company was moving spices and exotic goods from the East to Europe, Holland in particular. And tulips arrived.. But they weren't a big deal until 1634.”

He continued:

“And the reason they became a big deal almost overnight was because those same upper classes and nobility in Holland decided that tulips were now a status symbol.. So the price went through the roof very, very quickly. A tulip bulb would fetch 2,000 fluorine.”

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