The First Bubble — Tulips and the South Sea

Last time, we saw how the joint-stock company and the stock exchange — clever devices for sharing risk — were born in the Netherlands. But a market where people can freely set prices on things together has another face. When a price rises, people swarm to that very rising, pushing the price up further — the moment when frenzy, not reason, begins to decide the price. The first example of this began, surprisingly, with a single flower. An age when a tulip bulb was traded at a price rivaling an entire mansion. And an age when the hope for wealth that did not yet exist swelled to a scale that drew in whole nations. This is the story of the first frenzy, in which the very word ‘bubble’ was born.

When a Tulip Became the Price of a Mansion

The seventeenth-century Netherlands was an age made rich by the trade of the East India Company, where prosperous citizens sought goods to adorn their lives. One of these was the tulip, brought in from the direction of Turkey. Especially prized were rare varieties with flame-like streaks running through their petals. Later research holds that this beautiful patterning was produced by a kind of virus, but the people of the time did not know the reason, and simply went wild for the flower as something hard to obtain.

Bulbs take time to grow and multiply. With supply limited, ever higher prices were attached to popular varieties one after another. Before long, the trade shifted from the flowers themselves to the bulbs still in the soil and to written promissory notes for delivery in the coming season. Without seeing the real thing, notes were bought and sold on the bet that prices would rise — a venue for speculation had emerged that even craftsmen and merchants, not only skilled gardeners, could join.

Prices rose without limit, and a bulb of a certain rare variety is said to have been traded at a price rivaling many years of a skilled craftsman’s income, or a fine mansion. Everyone believed that ‘tomorrow it will sell for even more.’ Yet that trust was like a single thin sheet of ice. At the start of 1637, at one auction, a buyer to match the high price finally failed to appear. The instant the premise that ‘there is a next buyer’ broke down, the price collapsed like an avalanche. A note that yesterday had been worth a whole mansion turned almost into scrap paper.

Paper Money and a Dream — John Law’s Mississippi Scheme

About eighty years after the tulips, the stage moves to France. France at that time stood on the brink of national bankruptcy from repeated wars. Onto this scene came John Law, a financier of Scottish origin. He held a view novel for the age: that if paper money issued by a bank, rather than gold and silver coins, were widely used, the economy would move far more vigorously.

Law founded a bank in 1716 and took control of the company managing the development of the vast Louisiana colony France held in North America — the so-called Mississippi Company. He spoke of the enormous wealth said to lie in the New World and had people buy the company’s shares. And the paper money the bank had printed was used to buy those shares; shares were bought with paper money, and the rising share price in turn staged greater trust in the paper money. Expectation and paper money propped each other up, and the share price ran up without limit. Paris overflowed with crowds clamoring to buy shares, and people who suddenly made fortunes are said to have appeared one after another.

But the wealth of the New World did not exist as much as had been claimed. As doubts about the reality spread, people rushed to let go of their shares and convert paper money into gold coin, each ahead of the next. In 1720, the share price collapsed, and the scheme fell apart along with trust in the paper money. John Law was driven out of France, and this turmoil is later said to have been a distant cause of the French people’s long wariness toward paper finance itself.

The Summer the Word ‘Bubble’ Was Born

In that same year of 1720, across the sea in England, a very similar frenzy was swelling. Its protagonist was the South Sea Company, founded in 1711. Backed by trading privileges toward Central and South America, this company issued shares in return for taking on an enormous national debt. Before long the share price soared, together with schemes that drew in even high officials of government, and at the summer’s peak a share with a face value of one hundred pounds is said to have leapt to a level exceeding a thousand pounds.

The frenzy did not stop at the South Sea Company alone. Companies of dubious substance, claiming ‘with this you are sure to profit,’ were founded one after another, and people swarmed to their shares as well. Companies with no content, that only swelled — people likened them to a ‘bubble’ that bursts in an instant. This is said to be the origin of the word ‘bubble,’ used down to later ages.

To curb that bubble, Parliament passed a law to crack down on the founding of unlicensed companies, the so-called Bubble Act, in June 1720. Yet this very regulation became the trigger, and the share price that had swelled to its limit collapsed all too easily. Many people lost their fortunes, and confidence fell to the ground. One who suffered a great loss in this collapse is said to have been Isaac Newton, the scientist who unraveled universal gravitation. He is remembered as having left words to the effect that ‘I can calculate the motions of the heavenly bodies, but not the madness of people.’ Whether it is true is a matter of varying accounts, but this anecdote is still quoted to this day as words that capture the inscrutability of the market.

And so, from the seventeenth into the eighteenth century, humanity witnessed again and again the market’s other face — frenzy and collapse. Both the mechanism by which price calls forth price, and the pain left behind after the burst, were already in full assembly in this age. In time the stage of speculation leaves the old continent. Across the Atlantic, in a new republic that had just won its independence, merchants would gather beneath a single tree, and a market that was to become the center of modern finance was quietly about to give its first cry.