by Arushi Jain
About a couple of years ago, everyone was talking about the mysterious price rise fiasco around something called a ‘bitcoin’. Even people who had nothing to do with the financial world knew that bitcoin was something they could buy and it will surely give them great returns. The prices soared to a point where every economist was sceptical and was just waiting for the bubble to pop.
More than 400 years ago, a similar situation was witnessed in the European region of present-day Netherlands, where a commodity started getting valued so much that it had to be incorporated into the Amsterdam Stock Exchange. However, the kicker here is that the said commodity wasn’t a currency or some capital asset- they were a simple consumer durable- the flower Tulip.
In arguably what could be the earliest financial asset bubbles, the tulipmania of the 1600s was characterised by the typical symptoms of irrational price inflation. Tulips were an exotic flower species and its rarity was one of the key components in the bubble formation. Initially, it was a luxurious commodity, a status symbol for the affluent but soon became a way for merchants and traders alike to invest. They would purchase tulip bulbs and keep them for resale in future. The prices skyrocketed to irrational heights- they were sold for six figures in today’s dollar- until it reached a point where investors realised what they were betting on, a foreign flower. The prices plummeted and never rose back to its earlier heights and people who had purchased these bulbs and seeds lost loads of money.
The tulip asset bubble of the 17th century also called ‘tulipmania’ since then aptly describes how asset bubbles work. Even though the fact that a flower species could be priced at price of a house in 17th century Netherlands is as bizarre as it gets, this is essentially how asset bubbles work every time. People cease to expect in a rational manner and start factoring in extreme biases. The prices of the commodity or asset inflate to ludicrous heights until a point where the investors realise their erroneous ways and the bubble pops.
There is no specific reason or one could argue many financial and structural reasons for the bubbles bursting, for there is no real sustainable value to the asset and the bubble is merely a consequence of over inflated expectations. In this particular case the price of the tulip bulbs suddenly crashed when no bidders refused to show up for a bulb auction and as plenty of the ‘purchases and sales’ of tulip bulbs were made in form of future contracts, an abrupt drop in investor confidence in the commodities led the downfall of prices. Needless to say, the bubble bursting is accompanied by a sudden crash in market and stocks.
From bitcoin to tulipmania, from Japan’s financial crisis of the 1990s which led to its economy slow down to the dot com bubble of the 2000s, all asset bubbles have wreaked havoc in the financial systems of the economies, oftentimes even made impacts outside the economy. While the effect of tulipmania was limited to a specific section of the Netherlands, we have seen time and again asset bubble bursts vastly taking a toll on the economy as a whole more so if the assets in question are relating to housing, banking sector, credit etc.
When people lose track of the quintessential questions like ‘how much is too much’ and begin pumping in too much cash (and faith) in a particular asset, economics from the past has taught us that it will usually not end well. Regardless it seems like we will keep witnessing bubbles as expectations of one can be controlled but with the intertwined financial system, we have today, stopping bubbles seems unlikely.