As you were reading the title of this article you were probably frustrated with me for going off of my medicine again. Well aren’t you sweet for worrying about me, we have gotten so close over these past few weeks. Don’t you worry I am still fully medicated! However, in my medically induced comatose state, I pondered across something I found fascinating that correlates perfectly to behavioral finance. Have you ever heard some finance geek talking about a bubble and how the world is going to end because of it? Well just in case you haven’t, when someone is talking about a bubble they are referring to the overvaluation of an asset that has the potential to burst when people realize the intrinsic value of it. The scary part is when that bubble bursts the person that is still holding the asset will lose a significant amount of their money invested in the asset. When overvaluation occurs people begin to speculate on the asset, hoping they can buy and then quickly sell it for a profit before the asset loses value. Think of holding any overvalued asset as playing a game of hot potato and each time it gets traded it gets a little hotter until nobody wants to hold it anymore. Or in other words, the game is over! Well in 17th century Holland they played a game of hot tulip until some people were “trading their land, life savings, and anything else they could liquidate to get more tulip bulbs” (Beattie, Investopedia).
At this point, the title is probably starting to make sense and you are probably thinking, "I want some of his medicine". Too bad, it is a prescription.
This “Tulip Mania” that happened in Holland was a classic case of supply and demand. This means the same basic forces that caused some 17th century Hollander to trade her house for a flower guides your decision to spend $4.50 on a cup of coffee at Starbucks (seriously, though, why?). Nobody is above the basic forces of economics. Therefore, without the proper understanding of what is happening in the world around us, anyone can fall into the same trap that the Dutch did back in the 17th century. Knowledge is power, at least that's what my mom told me.
When the tulip was introduced to the Dutch in 1593 it thrived in their climate and became a symbol of their prosperous nation. Even though the flower was thriving, it was new to the country which means there was a classic case of scarcity. Scarcity means people are competing for the same resources, or put another way, there is not enough for everyone to get as much as they desire. It was not just the scarcity of these tulips that made them so special to the Dutch. These were special tulips. These tulips had 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” (Bettie, Investopedia). These tulips sound pretty cool, right? Probably thinking about that house trade right about now, huh? The unique aspect of the flowers made each individual flower scarce in its own right, almost like a snowflake. Well, between the scarcity of a newer product in a country and each individual tulip being unique in its own right from the disease the demand for these tulips were growing at an alarming rate. With demand rising the tulip’s price skyrocketed in accordance with consumer’s preferences for how they looked. All of these features had the perfect combination to create a bubble, and they did just that.
You might say, “Well those economic forces are around everywhere, that’s not a good enough reason to start an economic bubble with tulips!” Wow, how did you know that? Well, you are right. During the 17th Century, the Dutch Golden age was in full force and the Dutch had a booming middle class called the “Burgher”. Their main goal was to outshine each other through the consumption of goods. They did this because there was not a strict social class to automatically prove their worth within society. Therefore, to comfort all their insecurities they had to prove their worth through spending on goods (sound familiar?). When that consumption driven middle class found those unique tulips their trading hands started to tingle. They were ready to gamble for the chance at making a fortune and outshining each other with their glamorous diseased flowers. They started trading tulips as much as they could and anywhere they could. Their price was continually rising from 1634-1637. The price increased so much between that time period that by 1637 tulips could be more expensive than the most expensive houses in Amsterdam.
How could anyone think a tulip was worth that much? The answer; they probably never thought a tulip was worth more than a house. They just thought they could sell their tulips to the next sucker who would be foolish enough to buy it from them. It is similar to riding the momentum of the stock market. The goal is to follow the herd until the momentum stops and then sell your position at a peak price to the unsuspecting person who is too late to the party. Of course, the mania did not last; if it did tulips would probably be valued at a higher price than everything else in the world combined. People started to take their profits and the consumer demand for tulips began to fall, which eventually led to sellers looking for any buyers to take the tulips off their hands, no matter how large the loss. Suddenly, the first recorded economic bubble came and went, unfortunately, society has not learned much since.
If you were a teenager before 2008 you should definitely know what a bubble is. You should also know the kind of aftermath that a bubble leaves when it bursts – they are serious. People lose their jobs, families, and even their lives because of bubbles and crashes. A bubble can be a threat to any investor’s portfolio and it can cause ripples throughout the entire world. It is important to do your research before investing your money into anything. Whether it is the stock market, real estate market, or even education, the best way to protect yourself against a bubble is to have self-control. Do not become greedy if you do not think that an asset is worth your money. Just because everyone else is buying and selling does not mean it is your time to do the same. When the bubble bursts you will be there to pick up the cheap assets and laugh all the way to the bank, and guess what? You will deserve that payday because you were able to resist the temptations of the crowd. Being independent in thought is always a benefit when it comes to investing. Two-thirds of America is financially illiterate, do you really want to follow the crowd?