What’s It Worth?

July 31, 2017

Tulip for Robert's blog

An age-old question that is generally answered by – “what is someone willing to pay for it?”   As we often see, this can become quickly irrational particularly when the price is set on the hope or expectation of a future value or outcome.

The Dutch are famous for many things – renaissance painters, wooden shoes, Gouda cheese, canals and thousands of bicycles, but above all others are – their tulips.    Today, tulips and Holland are inseparable images, representing an attractive and potent brand identity recognized across the world.

What is less well known is that tulips are not truly from Holland!  They are (or were at least) imported.  The flower’s native range extends from the Iberian Peninsula, through the Middle East, north to Ukraine, southern Siberia and Mongolia, and east to the northwest of China. A beautiful perennial flower from the lily family whose import interest was made possible by a hardy dormant bulb along with Dutch’ shipping (East India Company – the world’s first publicly listed and traded company) and their accomplished horticulture capabilities.

By the 1620’s, the wealthiest in Dutch society were willing to pay extraordinary sums to obtain the latest, most spectacularly-colored tulip varieties. Particularly prized were those with dark striped “flames” on a lighter background; now known to be an epigenetic trait (in this case viral) which made their consistent production just that much more unpredictable.

Tulips typically require two to three years of seasonal growth and renewal before maturing to a flowering plant.  Prior to the (1620-1630’s) rapid run up of the Dutch tulip market, all purchases were priced during the spring season on flowering bulbs.  But as the demand continued to expand by ~1634, a futures market began on “yet to flower” bulbs in which contracts were bought and sold – and often resold five to ten times – before the first flower had ever appeared.   By removing the identity requirement (i.e. seeing a specific flower with confirmed and specific traits) the last piece of market innovation flew into action – bundling.   Trades were no longer on assets with a specific trait and value but on bulk or “bundled parcels” with implied but yet to be confirmed flowers.

Much has been written and speculated about what has been since coined “tulipmania.”  At its peak, the price for a single “Semper augustus,” one of the most sought after tulip varieties, was approximately equal to that of a luxurious Amsterdam home.  After going up over 20-fold in a period of about three months, it is clear that several factors contributed to the resulting crash of 1637 – perhaps the earliest highly studied market “bubble” in history.

Some have suggested that this market and resulting crash was not as much about irrationality as originally thought but instead related to changes in the regulation of futures contracts (voiding the obligation and shifting to options) – thus rapidly tilting value from seller to buyer.

Regardless of the trigger, perhaps the more instructive element of this history lesson was the mechanics of its rise.   The buyers of high-end tulips were not your average customers.  The principle buyers were the wealthiest shipping merchants of the day; merchants who themselves were in many ways the primary innovators of the financial markets that we see around us today.

Investing in shipping expeditions is not an asset class for the risk averse.  Each ship, its crew and provisions cost much more than any single business person could afford alone.  They needed to pool financial resources.  Although highly lucrative, each voyage faced extreme risk.  To address this, the Dutch pioneered “syndication.” Rather than put all their capital into a single voyage, investors (these shipping merchants) could place their bets on pools of voyages.  As investment price points were lowered and risk was spread, so was the resulting wealth.

These wealthy tulip buyers were part of a tightly-contained social network and a group accustom to taking risk.   Many were personal friends and often had long business histories with intertwined families and marriages.   The transactions were conducted during evening gatherings, where the buyer/seller interactions had high degrees of visibility.  Competition and family bravado added fuel.

Since these purchases were designed as future contracts – the majority of the financial obligation is paid later, it was easy to get over-exposed.  The contract to pay was deemed due only when the bulb “flowered.”  No flower, no milestone. However, if they did bloom as hoped, then huge invoices on large bundles of assets would follow.  And although these future contracts were outcome-triggered (e.g. contingent payments) they were also underwritten; backed by the very houses in which these flowers where intended to be showcased.

In the cold winter days of February 1637 before a single bulb of the year had revealed, the tulip market crashed and the obsession for the flower reset to pre-mania prices, with more than a few rich merchant’s estates lost not to “the sea” but to a different kind of misfortune – a loss of trust, in the value and perhaps also in the actual worth of the underlying assets.  Although beautiful, a tulip is just a flower after all.

What “manias” may surround us today?  In healthcare, perhaps the closest “tulips” could be in early stage biotech deals.   And yet, in this setting some real euphoria is blooming as well.  Over the last five years, we have seen a steady stream of remarkable new innovations change the lives of patients.  New cutting-edge treatments and many patients are living much longer.  In fact, some may even be “cured”… the most beautiful blooms of all.

On the tech side, blockchain (or least in its digital currency context) continues to blitz into indefensible prices, with bitcoin doubling since the beginning of the year and the upstart Ethereum up 4,500% over the same time frame.   As a disruptive technology, blockchain will rewrite the rules of transactional trust across diverse industries, but to be a generally useful currency, we will have to await the price stabilization that should occur as supply constrains.  As many emerging economies have witnessed, unchecked currency inflation becomes poisonous.

When new innovations “bloom” to reveal a full potential, it is truly inspiring and often hard to quantify their value in advance.  Few things cause us to pause, cower or to just reflect on the value of life itself like being told that we, or a loved one, has a life-threatening condition.  And then to be saved by a new treatment from what is expected is nearly priceless.   Similarly, when new cryptographies can help authenticate, secure the identity and full history of any asset, a new world of transactional trust is enabled.  And in a world of ever increasing privacy and data authenticity concerns, blockchain-like approaches are a timely new antidote for an ever increasingly digital world.  Only history will teach what they are truly worth.