Financial bubbles and busts happen as a means of keeping the market ‘honest’. As painful as they can be, these bubble/busts act as sort of a ‘reset switch’ for when things get over-valued. We all remember the relatively recent Tech and the Housing bubbles and certainly the way in which they ended. Not good. Looking back and hindsight being 20/20, the warning signs were all there, but many of us chose to ignore them and stay in the market, either out of naiveté or greed.
Bubbles/Busts went all the way back to the 1600s!
One of the most famous bubbles of all time, The Tulip Bulb Bubble took place in Holland in the years 1634-1638. Nearly everyone who was anyone was doing their part to raise the price of tulip bulbs back then, in fact tulip bulb speculation was as rampant as publicity agents at a Justin Beiber press conference. That’s pretty rampant, but I digress. Just in that 4 year time-frame alone, the price of tulip bulbs multiplied 100 times over. People were going crazy; mortgaging homes and borrowing against their businesses to buy tulip bulbs. Tulip bulbs, who could have imagined? In fact, it was said that during those 4 years, people were trading upwards of one thousand pounds of cheese for a single specimen of the rarest tulip bulb.
By 1638 however, people started to see the warning signs and began to question why the value increased with such reckless abandon. They began to lose faith in the value of the bulbs, and by the end of 1638, the bottom dropped out. In an attempt to stop the bleeding the Government of Holland set price controls which said that all tulip contracts could be fulfilled by paying a mere 3.5% of the originally agreed purchase price.
How Tulipalooza started:
The frenzy started around the year 1624, when an Amsterdam man who owned the only dozen tulip bulb specimens, was offered 3,000 guilders for one bulb, which is about $1680 in todays exchange. It is said that this sum, back in the 1620s was equal the annual income of a wealthy merchant. To the citizens of Amsterdam however, the tulip was the cue de gras and the most coveted asset in all of Holland.
Enter the term ‘Florist’
Around 1630, however, a new type of tulip financier (the florist) appeared and regarded themselves as professional tulip traders. These florists sought out flower lovers and speculators alike, and could be found conducting their business in hundreds of Dutch taverns. Tulip mania reached its peak during the winter of 1636-37, when some bulbs were changing hands up to ten times in a day. Word traveled quickly and the stories of overnight wealth encouraged people to drop a promising career in medicine, farming, or teaching to become a tulip speculator. As a result, the supply of tulip buyers grew, but the supply of bulbs did not. There was no way to keep up with demand. The market had to correct, and so it did, leaving many ‘would be speculators’ holding the proverbial empty bag.
What Tulip Bulbs and the Dollar have in common
This is a great illustration of how speculation can cause a bust with nearly anything of value. This is also a sobering example of how the word ‘tulips’ could be easily changed for the word ‘Dollar’. Both are highly speculative because they are not backed by anything of intrinsic value. Our dollar used to be backed by gold until President Nixon changed that in 1971. The Federal Reserve’s actions over the last 40 years with money printing, coupled with the move away from the gold standard has likely created an inflationary environment to where our dollar will never recover. Our money supply, compliments of Quantitative Easing (QE), has drastically expanded in the last 10 years. There are more dollars chasing a smaller inventory of goods and services.. see here, GDP growth has been anemic for the last 6 years. So what? Well the issue we have is, each dollar will have less tulips available for purchase, (to borrow from our tulip scenario) so therefore, the price of goods and services has to increase. Less goods and services+same or greater demand+diluted money supply=increased inflation. When less goods and services are available, their cost rises.
So, in an effort to thwart inflation we need to elect politicians who believe in preserving the value of our dollars and who recognize the Fed is doing a huge disservice to the value of our dollars. ( By the way, the Federal Reserve’s members are appointed, not democratically elected by the people, and the entity as a whole, is unaudited).
What are your thoughts on the Feds actions with respect to Quantitative easing?