Saturday, October 25, 2008

The Tulip

A tulip. Simple flower, not much history there.
However, there is a lot of history, and quite revealing at that.
The Tulip is not Dutch at all. An Austrian named Ogier Ghiselin de Busbecq extracted the plant for the Ottoman Empire (Turkey) in the 16th century, sending them to his friend in the Low Countries, now the Netherlands (1593.)
Ogier Ghiselin de Busbecq worked for the court of the Austrian, Ferdinand 1, Holy Roman Emperor. There’s no accident here, the Archduke that and is cited as the assassination that started the first world war is the distant grandson of Ferdinand the first (1503-1564), both being members of the house of Habsburg.
The resulting mania about this imported flower creates the seeds for a market derivative known today as the “futures” contract. Under the provisions of a futures contract, a speculator will purchase the bulbs for the current market price, but only effect the transaction at the end of the season. Since the cycle of cultivation is extraordinarily long in the case of tulips, the occasion to speculate becomes evident.
Seeds from a tulip will form a flowering bulb after 7–12 years. When a bulb grows into the flower, the original bulb will disappear, but a clone bulb forms in its place, as do several buds. Properly cultivated, these buds will become bulbs of their own. The mosaic virus spreads only through buds, not seeds, and so cultivating the most appealing varieties takes years.
Beginning in 1636 and abruptly ending in 1637, the “tulip mania” produced several innovations in trade. Short selling, which is the negotiation of trade in a commodity not held by the investor, was banned by the edit of 1610, but was prevalent enough that there was a need to re-instate the edict in 1636. Short sellers were not prosecuted under these edicts, but their contracts were deemed unenforceable.
As the flowers grew in popularity, professional growers paid higher and higher prices for bulbs without the virus (Tulip-breaking virus.) By 1634, in part as a result of demand from the French, speculators began to enter the market. In 1636, the Dutch created a type of formal futures markets in 1636 where contracts to buy bulbs at the end of the season were bought and sold. Traders met in "colleges" at taverns and buyers were required to pay a 2.5% "wine money" fee, up to a maximum of 3 florins, per trade. Neither party paid an initial margin nor a mark-to-market margin, and all contracts were with the individual counterparties rather than with the exchange. No deliveries were ever made to fulfill these contracts because of the market collapse in February 1637. This trade was centered in Haarlem during the height of a bubonic plague epidemic, which may have contributed to a culture of fatalistic risk taking.
The contract price of rare bulbs continued to rise throughout 1636. That November, the contract price of common bulbs without the valuable mosaic virus also began to rise in value. The Dutch derogatorily described tulip contract trading as windhandel (literally "wind trade"), because no bulbs were actually changing hands. However in February 1637, tulip bulb contract prices collapsed abruptly and the trade of tulips ground to a halt.
Now these are not small numbers: Tulip mania or tulipomania (Dutch names include tulpenmanie, tulpomanie, tulpenwoede, tulpengekte, and bollengekte) was a period in the Dutch Golden Age during which contract prices for bulbs of the newly introduced tulip reached extraordinarily high levels and then suddenly collapsed. At the peak of tulip mania in February 1637 tulip contracts sold for more than 20 times the annual income of a skilled craftsman. It is generally considered the first recorded speculative bubble. The term "tulip mania" is often used metaphorically to refer to any large economic bubble.
The Dutch government instates new rules to try and curb the instability in currency and value created by this flower.
People were purchasing bulbs at higher and higher prices, intending to re-sell them for a profit. However, such a scheme could not last unless someone was ultimately willing to pay such high prices and take possession of the bulbs. In February 1637, tulip traders could no longer find new buyers willing to pay increasingly inflated prices for their bulbs. As this realization set in, the demand for tulips collapsed, and prices plummeted—the speculative bubble burst. Some were left holding contracts to purchase tulips at prices now ten times greater than those on the open market, while others found themselves in possession of bulbs now worth a fraction of the price they had paid. Mackay claims the Dutch devolved into distressed accusations and recriminations against others in the trade.
The panicked tulip speculators sought help from the government of the Netherlands, which responded by declaring that anyone who had bought contracts to purchase bulbs in the future could void their contract by payment of a 10-percent fee. Attempts were made to resolve the situation to the satisfaction of all parties, but these were unsuccessful. The mania finally ended with individuals stuck with the bulbs they held at the end of the crash—no court would enforce payment of a contract, since judges regarded the debts as contracted through gambling and thus not enforceable by law.
And thus is the introduction of what we now know as an “options” contract. Speculators today use “options” versus “futures” to avoid the risk-side of the futures contract. Thereby, they retain the option of purchasing future assets at today’s prices, but not the obligation to do so.
Very sophisticated, but not very modern. The Dutch government introduced a penalty for non-execution, in order to stabilize speculation which had clearly run beyond her control. That legacy continues to this day. Stock-options are in abundant use to ensure that the speculating, ultra-rich segment of our society will continue to push prices of commodities forward, regardless of the intrinsic value of the goods. The decision by the courts of the Netherlands shows an incredible amount of bias towards the purchasers of the futures, the speculators and investors, none towards the farmers who create the crops.
Is it the same for Columbian coffee-growers?


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