Tulips and gold: The similarities and differences explored

Tulip mania

For some, gold remains a controversial asset to have in one’s portfolio. These critics contend that the rise in the gold price over the past decade is a bubble set to burst, what with no perceived value of gold apart from tradition.

We have a good number of reasons for being bullish in gold, but what we would like to focus on is the ‘bubble’ claim made by these critics. A historical example often cited is the ‘tulip mania’ of 17^th-century Holland. Information on this occurrence is actually scarce. The most popular account is that from Charles Mackay’s 1841 book ‘Extraordinary Popular Delusions and the Madness of Crowds.’ At the height of the tulip mania, a tulip bulb was reported to fetch several acres of land. Sounds crazy, doesn’t it? Apparently, buyers expected to be able to sell their acquisitions for a higher price, in a game of ‘The Bigger Sucker.’ It may have also been that tulip traders expected such demand, and prices, to be sustained.

Tulip mania understood today

Contemporary research questions the prices alleged by Mackay, due to the lack of veracity of the sources for these. Another contentious issue is the effect of tulip mania on Holland’s economy in general. Some have asserted that what happened with tulips was an isolated event, with other sectors not hit that hard. Others, meanwhile, claim that tulips were merely symptomatic of a Dutch crisis occurring simultaneously in other sectors of the country.

Some even argue that this mania was actually induced by below-market lending rates and increase in the quantity of monetary notes, which are the cause of bubbles in more modern times as well.

Understanding a ‘bubble’

Actually, ‘bubble’ would not be the right term to use if what is being referred to is a mere rise and fall in prices in a particular sector. It may be that demand did increase then plummet during the tulip craze, but the negative effects of these purchases would have been limited to the direct participants, and not the economy as a whole. The purchase of these tulips, even at prices we consider to be outrageous or foolish, would only be possible when consumption elsewhere is foregone. When interest in tulips eventually waned, this would have merely meant that demand shifted from tulips, to other goods. No crisis would occur in this shift in demand.

For example, just because a singer becomes less popular does not mean the music industry suffers. The drop in a singer’s popularity just means other bands or singers become more favorable to audiences.

The common element of major fluctuations

A real bubble and its bursting would involve a fluctuation of business in general, not mere shifts in preferences of consumers. This is only possible when there is a change in a certain element that pervades economic transactions, whether for tulips, apples or houses. What element are we talking about here? Money, which in an advanced exchange economy, is present in virtually all trade.

We have seen in recent history the bubbles that have occurred in publicly traded stocks and housing, which are derived from credit. Credit itself is not harmful, but the problem lies in a bank lending money that it actually doesn’t have. This means that additional consumption in an economy is undertaken even without a foregoing of consumption (savings) elsewhere. This absence of actual savings means less responsible lending, as well as the absence of profitable ventures by which to pay back loans. A bust is thus inevitable.

Mania for tulips in itself is not harmful

Tulip mania, if it was not financed by unbacked credit, would thus not constitute a bubble that can wreak havoc on an economy. The eventual drop in price would thus have been for the most part limited to those engaged in the trade of tulips. Besides, a drop in their price would mean greater affordability of goods in other sectors.

What about gold?

To be sure, even gold’s rise has been largely due to inflation of the money supply and expansion of unbacked credit. However, gold is precisely the alternative to falling currencies. Gold is the means by which a currency’s purchasing power can be made stable once more. Gold, being the definitive medium of exchange for thousands of years, is not something to go out of fashion. In addition, the extraction of gold and the increase in its supply is very slow in comparison with the ability to grow tulips and multiply tulip supply.

This is not to say that there won’t be price corrections. Also, gold-related stocks are likely to rise beyond the rate that gold rises, only to plummet when this stock bubble pops. The physical metal, however, has no replacement as medium of exchange, and its value in relation to other goods can be assured to stay consistent or grow over time.