Don't Let the Market Play You For the "Greater Fool"

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More than a decade has passed since the dot-bomb implosion, and many of us are still amazed that so many investors got sucked into such an insane speculative financial mania.

The thing is, it has happened many times before.

For instance, in the mid-1600s Holland literally drove itself to ruin over flowers - tulips, to be precise.

Referred to today as Tulip Mania, Tulipomania, or Tulpewoerde, it was the first recorded speculative mania in modern history.

Indeed, the financial frenzy that unfolded between 1634 and 1637 crashed so hard that it actually helped smash the Dutch economy, transforming one of the world's first superpowers into an economic backwater.

Writing nearly 200 years later in his classic work, "Memoirs of Extraordinary Popular Delusions and the Madness of Crowds," historian Charles MacKay said:

"In 1634, the rage among the Dutch to possess [tulip bulbs] was so great that the ordinary industry of the country was neglected, and the population, even to its lowest dregs, engaged in the tulip trade. As the mania increased, prices augmented, until in the year 1635, many persons were known to invest a fortune of 100,000 florins for the purchase of 40 roots."

For some context, the annual income of a middle-class urban family in Holland was 200 to 1,000 florins. (University of Kansas Prof. Mark Hirschey estimated that peak prices for tulip bulbs ranged between $17,000 and $76,000 apiece in today's money.)

Tulip Madness Takes Hold

Like most manias, Tulip Madness took hold during a period of prosperity, when credit was easy to obtain. The Netherlands had the world's most powerful navy, accounted for half the world's shipping trade, was a center of science and, with artists like Vermeer, was also the cultural center of Europe.

The country was newly affluent and tulips, which had come to Europe in the late 1500s, were difficult to obtain and became a way to flaunt that wealth.

Naturally, the DeVries wanted to keep up with the Van Dijks, and tulip prices began their upward march.

It wasn't long before tulips with variegated color patterns (caused, ironically, by a nonlethal virus), became the most valued. Cultivators scoured their gardens hoping for "a strike," which was akin to hitting the lottery.

As MacKay relates, it wasn't long before the business of Holland became, well, tulip bulbs.

By 1636 regular tulip "marts" were established on the Amsterdam Stock Exchange, and in such centers as Rotterdam, Harlaem, Leyden, Alkmar and Hoorn. Grading systems were established - the more striking the pattern, the higher the price.

Theft became a problem. And so did market manipulation.

The get-rich crowd descended on the "market" - the stock jobbers, promoters and profiteers, who goosed prices just like the pump-and-dumpers do with worthless penny stocks today.

Market riggers would even sometimes release specially trained animals (pigs were a favorite) into rivals' tulip fields to dig up, eat and flat-out destroy tulip bulbs - eradicating competition and creating sudden shortages.

Serious tulip "investors" employed messengers to deliver updates on marketplace changes.

Futures markets were created and speculators wrote contracts they had no intention of honoring; they'd just flip the contract to the next "Greater Fool" and pocket the profit.

The rich and the regular speculated together, with some selling homes and farms - often at fire-sale levels - to raise cash for tulip speculation.

All the while, prices rose - even soared. At one point, tulip prices were doubling every day.

No More "Greater Fools"

Needless to say, this couldn't continue. With most of the country's population all in, there were no more "Greater Fools" to sell to.

In the early autumn of 1636, the prudent - or perhaps the "insiders" - began to sell their tulip holdings. Prices hesitated, fell a bit, seemed to stabilize, and then fell some more.

The decline steepened, and finally prices collapsed - dropping about 90% in six weeks. Defaults, margin calls and liens were the order of the day.

Traders beseeched the government to step in, but the request was met with an order to "settle it amongst yourselves." When no agreement could be reached, leaders agreed that all contracts negotiated at the mania's height were null and void.

Prices continued to fall, and the courts refused to honor tulip-related debts, since these were actually viewed as gambling debts, and therefore weren't liabilities in the eyes of the law.

Stock jobbers tried to reignite Tulip Mania, first in Holland and then in other places in Europe, but were unable to do so.

The Netherlands was never again the world leader it had once been.

One final footnote: As Prof. Hirschey noted in a research paper "How Much is a Tulip Worth?" the price paid for a single Viceroy tulip bulb at the height of the mania was $34,584. Today, horticulturists purchasing bulbs of particularly rare varieties of tulip might pay 30 cents to 40 cents each - or what the bulbs sold for after the collapse of Tulip Madness.

I wanted to tell you this story today because it's one of my favorite investing lessons.

My co-author - top-tier money manager Anthony Gallea - and I wrote about Tulip Mania in our 1998 book "Contrarian Investing: How to Buy and Sell When Others Won't and Make Money Doing It."

It's a great story because of the valuable lessons to be learned.

The most important: Avoid being the "Greater Fool" by searching out solid investments and constructing a well-thought-out portfolio.

That's our mission here at Private Briefing where we've already shown more than 14,000 investors how to invest and profit - but without becoming the next "Greater Fool." To learn how you can join our group, just click here.

With the benefit of hindsight, it's easy to see that the most disastrous mistakes that investors make - like laying out your life savings for a tulip bulb, or an Internet stock - should be the easiest to avoid.

But in the heat of the moment - in the pursuit of profits - it becomes surprisingly difficult.

We can show you how to reach life's destinations - richer and less stressed.

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About the Author

Before he moved into the investment-research business in 2005, William (Bill) Patalon III spent 22 years as an award-winning financial reporter, columnist, and editor. Today he is the Executive Editor and Senior Research Analyst for Money Morning. With his latest project, Private Briefing, Bill takes you "behind the scenes" of his established investment news website for a closer look at the action. Members get all the expert analysis and exclusive scoops he can't publish… and some of the most valuable picks that turn up in Bill's closed-door sessions with editors and experts.

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