Out of Cheese

More reading of this week’s New York Times Magazine got me to look up the history of the Dutch tulip bubble. For those of you who aren’t quite as into history, the Dutch tulip bubble was the first generally recognized economic “bubble”, occurring in the mid-1600s when crazed investors bid up the price of tulip bulbs, of all things, to a ridiculous amount before the market crashed. People often draw analogies between the tulip bubble and the dotcom bubble or today’s real estate prices.

Problem is, apparently there was no tulip bubble. A bit of reading in Wikipedia and Slate points out that what actually happened was that a slip in the tulip futures market — yes, they had futures markets in the 17th century — caused some well-connected investors to push through a law changing existing tulip futures contracts into tulip options contracts. This substantially reduced investors’ risk, thereby pushing up prices dramatically as you’d expect in any normal market. The price increases started when the law took effect, but they didn’t settle down until the law was announced a few months later. Investors who had inside knowledge therefore came out ahead, as you’d expect.

So the next time someone claims that modern markets are being irrational and points to the Dutch and their tulips, you might want to think about whether the new markets are as irrational as they sound. Maybe the markets are insane, but we can’t blame that on anything that started with tulips.