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What Tulips Can Teach Us

Long before anyone ever heard of mortgage backed securities (MBS), collateralized debt obligations (CDO), credit default swaps (CDS), or the other financial instruments that have faltered during the current recession, there was semper augustus, also known as the tulip. To Calvinists of 17th century Holland, nothing was as desirable or valuable.

The exotic flowers, brought over from the Ottoman Empire, became the object of a national obsession. Entire markets were created just to trade tulips and the markets were soon swamped with speculators. As Mike Dash notes in Tulipmania tulip speculation lead to the first-ever futures market. At the height of the tulip-mania, between 1636 and 1637, single bulbs could be sold for 100,000 guilders. By way of comparison, a ton of butter cost around 100 guilders, a skilled laborer might earn 150 guilders a year, and “eight fat swine” might cost 240 guilders.

The story of any “mania” offers insight into a phenomenon behavioral economists like to refer to as herd behavior. Herd behavior is the tendency for individuals to mimic the actions of a larger group.

Herd behavior happens because of the social pressure of conformity. After all, even if you are convinced that a particular idea or course or action is irrational, you might still follow the masses, believing they know something that you don’t. This is especially prevalent in situations in which an individual has very little experience, such as the Tulip trade.

Tulip mania is merely one extreme example of herd behavior; a more mundane example can be seen in front of any Apple store anytime a new product is launched.

After the tulip market crashed, a compromise was brokered that let most traders settle their debts for a fraction of their liabilities. The overall fallout on the Dutch economy was negligible. This was doable only because the stock exchanges refused to allow any sort of tulip trade in the first place. In the same vein, the new financial regulations authored by Senator Dodd and Representative Frank aim to create separate entities to trade potentially dangerous derivatives. Or as Mark Twain would remark: “History doesn’t repeat itself, but it does rhyme.



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