A Warning From History for Dot-Com Investors
by Mark Tarses
(I wrote the article below in January, 1999. Since then, the mania for stocks in unprofitable internet companies has come to a crashing end. However, the lessons of Tulip Mania should be learned by every generation.)
Lately, I've been referring to internet stock investing as "tulipmania.com."
I believe that internet stock mania will be remembered by future generations as one of the greatest investment bubbles of all time. I also believe that like other great investment bubbles, it will pop!
It seems that one generation never learns from the investment follies of previous generations. The same arguments that were used by speculators during every previous investment bubble are being used today by internet stock buyers and promoters. I am reminded of a line from Hegel that "The lesson of history is that men learn nothing from the lesson of history."
Consider the history of tulip mania below. Can you see similarities with internet stock investing today?
If you have never heard of tulip mania before, you might suspect, as you are reading the story below, that I made this all up. The history of tulip mania is bizarre and unbelievable! (As anyone who knows me well can tell you, I love to tell fantastic stories that leaves people wondering if it really happened or if I'm just the world's biggest liar! Well, tulip mania really happened!)
What was tulip mania? The first tulips arrived in Western Europe in the late 1500s from Turkey. They were an immediate hit, especially in Holland. People were fascinated by this unusual and beautiful oriental flower. Within a few years, the Dutch had developed an astonishing variety of tulips. They developed tulips in hundreds of unusual shapes, colors, and color combinations. Then, fascination turned into mania.
Today, you can buy a bag of tulip bulbs for around $2. However, in the 1630s, when tulip mania swept over Holland, Dutch traders bought and sold tulips at staggering prices. In smoke-filled taverns all over Holland, tulip bulbs were bought and sold at prices that rose, often dramatically, nearly every day.
Tulip bulbs were traded at public exchanges in much the same way that shares of stock are traded today, and tulip prices were listed in Dutch newspapers just like stocks as well. During the peak of tulip mania, between 1634 and 1637; people in Holland abandoned their jobs, businesses, wives, homes, and children to grow tulips full-time.
Tulip frenzy. Tulips were the "hot topic" of conversation in Holland. Tulips were all that people were talking about and thinking about. Tulip frenzy influenced every aspect of people's lives. Dutch clothes, porcelain, linens, and furniture of the period were often covered with tulip designs. People made their food, including breads, cakes, and sausages in the shape of tulips. Many Dutchmen sold everything they owned and then borrowed as much money as they could in order to speculate on tulip shares and tulip bulbs.
The word "bourse" (stock exchange) derives from tulip mania. Those who speculated on tulips held their trading sessions at the offices of the Dutch noble family Van Bourse. How high did tulip prices get? Unbelievably high! Some wealthy people traded everything they owned for a single tulip bulb. While it is hard to say just how much 17th century Dutch guilders and florins were worth in today's money, the following 17th century bill of sale will give you an idea of just how high prices got.
In exchange for one desirable tulip bulb known as a "Semper Octavian" or "Semper Augustus", a Dutchman paid "two wagon loads of wheat, four loads of rye, four fat oxen, eight fat swine, twelve fat sheep, two hogheads of wine, four barrels of beer, two barrels of butter, 1,000 pounds of cheese, a marriage bed with linens, and a sizable wagon" to haul it all away. All this for just one tulip! This transaction was not unique.
There are many surviving receipts and contracts from the period showing that people traded large houses, businesses, ships, and farms for a single tulip bulb. People also borrowed huge sums of money, regardless of the terms of the loan or the interest rate, to speculate at the tulip market.
Warnings ignored. Of course, not everybody was sucked into tulip mania. There were influential people who saw this for what it was, a speculative investment bubble. These people tried to warn tulip speculators that the prices being paid for tulips were absurd, and that this mania had to come to a bad end. They pointed out that tulip prices were completely out of proportion to their value or the cost of growing new tulips.
Dutch government officials issued regular public warnings, but their warnings were ignored. Not only were the warnings ignored, but tulip speculators got angry at the people making them. Some government officials were threatened. Some were physically assaulted.
This is one of the common characteristics of all investment bubbles - people who are caught up in a mania do not want to hear arguments based on logic or reason.
The Crash. When tulip mania came to an end, the end came quickly, and it was painful. On April 27, 1637; the Dutch government issued a decree that tulips and tulip bulbs were products, not investments, and that they had to be bought and sold on that basis. That meant that tulips had to be paid for in cash, not with I.O.U.s. It also meant that Dutch banks could no longer accept tulips as collateral for loans.
With no new money coming into the market to keep the price spiral going, and with banks calling in their tulip loans, tulip prices collapsed overnight. Tulip owners and tulip stock speculators were financially ruined, as were the people who lent them money and extended credit to buy tulips. Thousands of people went bankrupt. Many businesses and financial institutions closed their doors, never to reopen. The whole country was left impoverished.
The aftermath. In some ways, Holland never fully recovered from tulip mania. There were so many bankruptcies that the national treasury was exhausted as tax revenues plunged. The Dutch army and navy had to be dramatically reduced as there was no money to pay for them. As a result, Holland lost many of its overseas colonies.
New York is New York, and not New Amsterdam, because of tulip mania. In the 1640s, England was able to take New Amsterdam away from the Dutch without firing a shot since there was no Dutch army or navy left in the New World to defend it.
Some small remnants of New Amsterdam still survive. Some neighborhoods in New York City still bear their original Dutch names, such as Harlem, Bedford Stuyvesant, & The Bronx. Many prominent families in upstate New York trace their ancestry back to New Amsterdam: the Vanderbilts, the Van Burens, and of course, the Roosevelt family.
I sometimes wonder what the United States might be like today if it hadn't been for tulip mania. We might all be speaking Dutch right now and eating Erwtensoep!
Erwtensoep is a popular Dutch thick pea soup. It has cubes of pig fat, slices of blood sausage, and cracked pig's knuckles in it. (I am told that it tastes as good as it sounds! How good does it sound?)
Why did they do it? Why did well educated and financially savvy Dutchmen pay such absurd prices for tulips? How could so many intelligent people become so irrational?
Mania mentality. Investment bubbles result from mass mania psychology. This is a form of mob or herd psychology. It is highly contagious and spreads rapidly!
There are 3 things that always seem to be present in the minds of people who have been sucked into an investment mania:
1. Everybody else is doing it. People feel that an investment must be safe if "everybody" is recommending it, and "every-body" is buying it. It is the belief that the safest place to be is in the middle of the herd.
2. The fear of being left out. People fear being ridiculed or looking foolish for passing up their one great opportunity in life to get rich quick.
3. The still bigger fool theory. People were willing to pay absurd prices for tulips because they were sure that, regardless of what price they paid, somebody else would pay even more for them in the near future.
Of course, some people might say "Well, all this happened over 300 years ago. Things are different now. Something like tulip mania could never happen again." Wrong!
Although tulip mania was a particularly memorable investment bubble, it wasn't the first or the last big bubble in history. There are investment bubbles in every generation.
Holland and tulips today. Today, growing tulips is still Holland's most popular pastime. Huge amounts of Holland's very scarce land is used to grow tulips, but now, tulips are profitable. Huge numbers of tourists visit Holland to see the tulip gardens and attend tulip festivals, and Dutch tulips are sold all over the world.
T.V. Home Shopping Mania. While internet stock mania has many similarities to other famous investment bubbles in history, including tulip mania, the South Seas bubble, and Florida real estate the 1920s; I think that internet stock mania is most similar to the T.V. home shopping bubble of the 1980s.
In 1985, investors went nuts over companies that sold merchandise on dedicated cable T.V. channels or through long infomercials on regular broadcast T.V. stations.
The hottest stock in this group was the Home Shopping Network. Almost all the major brokerage firms were recommending it. In 1986, the stock in Home Shopping Network went from 18 to 133 in less time than it takes to say "cubic zirconia."
Even at 133, many respected brokerage firms, such as Goldman Sachs, were still telling their clients to buy the stock because "it can only go higher." But within a year, all the stocks in this group collapsed, most of them losing over 90% of their value from the peak of the bubble. In the end, all of these companies either went bankrupt or were bought up cheaply by large conglomerates.
While a lot of people are too young to remember the T.V. home shopping bubble of the 1980s, many internet stock investors don't remember it simply because they don't want to. (Do you remember T.V. home shopping mania? Do you recall the "genuine faux pearl snowball rings" that Home Shopping Network used to peddle 24 hours a day?)
History repeats itself. In many ways, the arguments for buying internet stocks are eerily similar to the arguments for buying T.V. home shopping stocks in 1986.
T.V. home shopping was touted as a "marketing revolution," "electronic retailing," and "the end of conventional retail stores." People caught up in T.V. home shopping mania argued that "If people can buy things from the comfort of their own homes, then why go to stores?" Isn't this the same argument that we hear today for buying stock in unprofitable internet retailers like amazon.com and etoys.com?
After the great stock market crash of 1929, Will Rogers said "I am not so much concerned with the return on capital as I am with the return of capital." This became one his most frequently quoted lines in the 1930s. It was very good advice.
Investors today have become so obsessed with making big bucks on Wall Street that many have completely forgotten about risk. Thats a bad sign - when investors aren't concerned about the risks of their investments and don't want to hear warnings or any negative news.
Is an internet stock crash coming? I don't know, but I do know this: Most internet companies are losing money and have no way of ever making money. We live in a market economy, and in a market economy, a business must either make a profit or go out of business. It is as simple as that.
Copyright 1999 by Mark Tarses.
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