The Stupidest Bubble in History

On this day in economic and financial history ...

The most iconic -- and most ridiculous -- bubble the world has ever seen peaked on Feb. 3. It wasn't the dot-com bubble, the housing boom, the social-media bubble, or even the frenzy over Beanie Babies. This bubble peaked far earlier -- on Feb. 3, 1637. That was the day Tulipmania finally exhausted itself.

The tulip was a strange sort of national fashion craze in the United Provinces, which is now known as the Netherlands. A rare and attractive flower, the tulip can bloom in a wide range of colors, and its long growing time only served to enhance its prestige in the eyes of the Dutch. The arc of Tulipmania has been chronicled most memorably in Charles Mackay's Memoirs of Extraordinary Popular Delusions and the Madness of Crowds, first published in 1841. Mackay writes  that from the turn of the 17th century "until the year 1634 the tulip annually increased in reputation, until it was deemed a proof of bad taste in any man of fortune to be without a collection of them." By this point, tulip speculation led to the neglect of popular industries, and a year later, "many persons were known to invest a fortune of 100,000 florins in the purchase of forty roots."

To put that in perspective, one historic Dutch currency calculator pegs the value of 100,000 florins (or guilders -- the terms are often interchangeable) in 1635 as the equivalent of 335 years of wages for an unskilled worker, or $9.4 million in current prices. At 2,500 florins apiece, these tulip bulbs could be exchanged for:

Source: Charles Mackay's Extraordinary Popular Delusions and contemporary cost reports.

Keep in mind that this is actually far less costly today than it would have been in antiquity, thanks to improvements in agriculture and manufacturing techniques: 2,500 florins would really be worth more than 10 times as much as the modern equivalent of these wares.

Mackay explains the absurdity of the situation at length with stories, one of which concerns an ignorant sailor who made off with a rare bulb and ate it under the impression that it was an onion, having "a breakfast whose cost might have regaled a whole ship's crew for a twelvemonth." Another folly took place when an English amateur botanist also mistook a tulip bulb for an onion and decided to peel it with a knife for closer examination.

A number of factors contributed to the growth of Tulipmania, including the wealth generated by the massive Dutch East India Company, low barriers to entry into the tulip trade, a loose monetary policy in the Bank of Amsterdam, and a plague that wiped out a fifth of the Dutch population as the bubble was peaking (which may have encouraged greater risk-taking, as the threat of death was always near). Between the start of 1637 and Feb. 3, some individual bulbs traded hands 10 times, increasing up to tenfold in price during these frenzied transactions. After the bubble popped, panic gripped speculators across the country as they struggled in vain to unload their bulbs. Prices declined by 95% within weeks.

Is such madness impossible to replicate today? Consider the following hypothetical scenario. Today, the Dow Jones Industrial Average (^DJI -0.12%) is worth, let's say, 63 points. In a few weeks it will be worth 381 points. A few weeks after that, it'll be worth 41 points. That's a 500% gain followed by a 90% loss. It really happened -- just on a longer timeline. That's how the Roaring '20s led to the Great Depression. Or, more recently, consider the dot-com bubble. In five months, E*TRADE's (ETFC) stock went from a value of $55 to $625, more than a tenfold increase. In the year after it peaked, E*TRADE's stock lost 65%, and a decade after its peak, E*TRADE was worth 97% less. Many other dot-com stocks are simply gone.

It's easy to consider ourselves more enlightened than those silly Dutch and their tulip bulbs, but even today there are many examples of irrational and unsustainable exuberance. The smart investor knows better than to get swept up in the mania of the moment.

Diesel-powered profits
Cummins (CMI -1.09%) was founded by C.L. "Clessie" Cummins on Feb. 3, 1919. Cummins quit school in the eighth grade to "be a machinist and make things," and he found early success in the first Indianapolis 500 race, where he served on the winning car's pit crew. As an early diesel engine manufacturer, Cummins was integral in disseminating this gasoline competitor technology, and Clessie Cummins himself was a tireless advocate. The first Cummins engine, a six-horsepower design, was built in April 1919. In 1930, Clessie Cummins personally undertook the first long-range diesel-powered road trip, from Indianapolis to New York City. A year later, a Cummins engine became the first diesel-powered engine to crack the 100-mile-per-hour barrier.

In late 1947, Cummins went public with a market cap of approximately $4 million. Six decades later, its market cap had grown to $12 billion -- an annualized growth rate of 14.3%.

Cover the world
Henry A. Sherwin and Edwin Porter Williams founded Sherwin-Williams (SHW 0.58%) on Feb. 3, 1870. Officially incorporated in 1884, this new paint manufacturer quickly found its footing in the post-Civil War era, reaching international status by 1892 with the opening of an operation in Canada. Sherwin stood as CEO from 1884, when sales totaled $400,000, to 1909, when the company earned more than $10 million. The company went public 11 years later and has grown into one of the world's leading manufacturers of paint, with sales of $7.1 billion in 2009. In the century following Sherwin's retirement, the company's annual sales have grown by nearly 71,000%.

Don't tax me, bro
On Feb. 3, 1913, Delaware ratified the 16th Amendment to the United States Constitution, which gained it enough votes to become the law of the land. The 16th Amendment reads as follows:

The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.

As you settle down for a long and frustrating attempt to calculate your taxes, and to weasel out of as many of them as possible, thank Delaware (and the other 41 states that ultimately ratified the amendment) for making it possible. In fiscal year 2013, a century after ratification, federal, state, and local governments are expected to collect about $2.1 trillion in income taxes.

Gimme that paper
Trade and exchange in the American colonies was originally conducted exclusively in coinage, which could be difficult in light of the rarity of gold and silver. It was not until Feb. 3, 1690, that the first paper currency was issued in the Western Hemisphere. The government of Massachusetts printed up promissory notes on that day to cover the costs of a failed attack on Canada during the early days of the French and Indian Wars. By the time the American colonies united to fight against Britain, paper money became so commonplace that it was considered worthless -- "not worth a Continental," in the parlance of the day.

At the end of 2007, approximately $829 billion worth of United States currency was in physical circulation, with much held outside of the United States. Paper currency lasts from between 21 months, in the case of the $1 bill, to 7.4 years for $100 bills. Most circulated currency is actually $100 bills -- nearly 80%, in fact.

The largest merger in history
On Feb. 3, 2000, after a contentious takeover effort had been thrice rejected, German conglomerate Mannesmann finally agreed to a $183 billion buyout offer from Britain's Vodafone (VOD 1.10%). The deal, reached less than two months after AOL announced its merger with Time Warner, and occurring near the peak of the dot-com boom, remains the largest corporate buyout in history. Mannesmann's then-recent acquisition of Orange, the third-largest British mobile carrier, made it the ideal target of a megamerger, as Vodafone had not expected the sudden invasion of well-financed foreign competition.

The market value of the combined Vodafone-Mannesmann was then estimated to be $365 billion. Vodafone raised much of its acquisition costs through bond issuance, and Mannesmann shareholders wound up with 49.5% of the combined company, which retained the Vodafone name. To meet European regulatory approval, Vodafone was required to divest the Orange brand, and the company also wound up spinning off Mannesmann's manufacturing operations. A decade after announcing the deal, Vodafone was worth $118 billion , a 68% decline from its merger valuation. That's still better than the AOL Time Warner deal, but not by much. Bubble-era mergers might look impressive in terms of sheer financial scale, but they've been anything but impressive for shareholder returns.