What do Tulip Manias, Social Security, and the Stock Market all have in common? Enquiring minds just might wish to consider this fairy tale comparison.
When tulip prices started to rise in the 1630s, many Dutch burgomasters (the local mayors) started to invest in tulip bulbs. In the autumn of 1636, demand for tulips sagged as German princes ravaged by the Swedes in the Battle of Wittstock, began digging up their bulbs and selling them. The sudden glut caused prices to fall, and Dutch burgomasters began losing money. Rather than take their lumps, these politically connected investors tried to change the market rules on tulips. Ultimately, the burgomasters succeeded in ironing out a deal whereby the obligation to purchase bulbs at a fixed price would be suddenly converted into an opportunity to do so. In other words, they transformed tulip-bulb futures contracts into tulip-bulb options. The action was ratified by the Dutch legislature. On Feb. 24, 1637, the Dutch florists “announced that all futures contracts written since November 30, 1636 and up until the opening of the spring season, were to be interpreted as option contracts”. In the worst-case scenario, investors would lose 3 percent of the price of the contract. In the best case, prices would rise above the strike price, and they could make an instant profit while assuming the minimal 3 percent risk. As a direct result of these sudden “rule changes”, people assumed there was little to no risk in buying tulip options, and the market exploded. By February 1637, the price of tulips had risen 20 times.
The demand for rare tulips increased so much that regular marts for their sale were established on the Stock Exchange of Amsterdam, in Rotterdam, Harlaem, Leyden, Alkmar, Hoorn, and other towns. Symptoms of gambling became obviously apparent. The stock-jobbers, ever on the alert for a new speculation, dealt largely in tulips, making use of all the means they so well knew how to employ to cause fluctuations in prices. At first, as in all these gambling mania, confidence was high and everybody gained. The tulip-jobbers speculated in the rise and fall of the tulip stocks, and made large profits by buying when prices fell, and selling out when they rose. Many individuals grew suddenly rich.
At last, however, the more prudent began to see that this folly could not last for ever. Rich people no longer bought the flowers to keep them in their gardens, but to sell them again at cent per cent profit. It was seen that somebody must lose fearfully in the end. As this conviction spread, prices fell, and never rose again. Confidence was destroyed, and a universal panic seized upon the dealers. Substantial merchants were reduced almost to beggary, and many a representative of a noble line saw the fortunes of his house ruined beyond redemption. After the crash was rolling, people demanded the government “do something.” Initially, the government offered to buy the options at 10% of face value. But as prices plunged even lower, the government could not afford to follow through.
Fast forward to 2005.
The US government, weary of war with Iraq and facing increasing military expenditures as well as rising pension obligations and Social Security promises that can not be met, desperately needs a way to support a potentially sinking tulip bulb market (otherwise known as the US stock market). The head US burgomaster (otherwise known as President Bush) has his own “rule changes” in mind (otherwise known as Social Security reform). It seems all we have to do to bail out Social Security and other pension obligations is to pass a law requiring the common people to purchase tulip bulbs (stocks) with a portion of their income from each and every pay check. Even though many think the “tulip fund” will be solvent for another 14-40 years, the head burgomaster has decided that “rule changes” are his top priority.
Supposedly tulip bulbs purchased today will be harvested when individuals retire and those bulbs will provide a source of retirement income. It just so happens that a side benefit of this mandatory infusion of cash into the tulip markets is a means for the wealthy burgomasters in general (otherwise known as CEOs and stock option holders) to sell their bulbs before they rot. The proposed rule changes will also guarantee fees for the tulip bulb dealers (otherwise known as brokerage houses and insurance companies selling tulip annuities). These fees are an expression of gratitude for the massive contributions paid by the bulb dealers to the head burgomaster in his bid to get re-elected. Bulb dealers were ecstatic when their candidate won, and immediately the price of bulbs shot up nation wide. All that remains now is for the Dutch Legislature, excuse me I mean US Congress, (see how confusing this gets?) to ratify the proposed rule changes.
In 1982 the common people were told that social security taxes would be raised to guarantee solvency of the “tulip fund” (otherwise known as the “Social Security Trust Fund”). Now 20 years later, the common people are told there is no money left in the “tulip fund“, that it was all spent, and that we need “rule changes” to guarantee the future solvency of the fund. These changes supposedly will revitalize our under-funded tulip fund.
Will these rule changes be any more successful than what ultimately transpired in 1637?
Enquiring minds want to know!
Unfortunately, our fairy tale must end here.
It will take many years before we know for sure but the up front cost to find out is a mere 1-2 Trillion US$ right now.
Thanks to my friend John Mozdzen for initially coming up with the idea for this article.