CHAPTER 1

The universe in a tulip bud

How the seventeenth-century flower market can explain financial crises

It was glorious: you took what you had saved up for a down payment on a house and

invested it, and in a little while you had enough to buy a house. In cold hard cash. Making

money had never been easier. Everybody wanted a piece of the action. People even quit

their jobs to do nothing but speculate on the financial market. And it worked.

Sound like something you’re familiar with? But we’re talking about a different

market here: the buying and selling of tulips, a business that ‘blossomed’ in Holland in

the seventeenth century. Europe’s well-to-do took a liking to these flowers as soon as

they arrived from Turkey. And the Dutch, who knew how to make money just as well as

they did windmills, started planting loads of bulbs to supply the buyers.

Then something unforeseen crept into the story: a virus. When this bug

contaminated a tulip, it weakened the flower and damaged its pigment. Awful for

the plant, great for humans, since the injury enhanced the flower’s beauty, leaving

it streaked with milky white veins. The virus only attacked once in a while, however,

making this variety rare and unique. So unique that it earned an ostentatious name

– Semper Augustus – and an obscene price. In 1624, in Dutch florins, one bud cost as

much as a house in Amsterdam – or to couch it in terms of today’s ostentatious names

and obscene prices, it would have been worth as much as a Cartier Submariner Rolex:

$100,000.

Soon Semper Augustus was no longer just a luxury but nothing but a luxury. Its

steep price pushed up the quotations on other tulips – the mere existence of a $100,000

Rolex makes a ,000 one seem cheap, right? So the same thing happened with

regular tulips. Just being a tulip was good enough; there were plenty of people eager to

pay top florin for any variety.

Florists would only do business in the spring, when the bulbs were flowering. But

as prices began rising, this practice quit making sense. If you were a florist and needed

money in the middle of the winter – months before you could sell your plants – you’d

have no trouble raising capital: all you had to do was sell the bulb itself, without the

flower, and let the customer wait for the tulip to appear.

Thus a new market was born. Speculators began buying heaps of bulbs in

hopes of reselling them at a higher price when the flowers showed their faces. You’ve

got to admit, it was a very shrewd investment since prices wouldn’t quit climbing. The

speculators didn’t even have to actually take the bulbs home. They simply kept a

contract (a “note,” in financial jargon) that ensured their right to the money that the flower

would later earn.

It wasn’t long before the contracts themselves were being traded. Someone who

had paid 1,200 florins1

go up in the spring would sometimes prefer to sell to someone else for 1,300 florins

and pocket the profit right away, rather than waiting. This someone else might then find

another someone else willing to pay 1,400 florins and so would sell off the note, taking

home an easy 100-florin profit. It was such a sure thing that the more cunning started to

engage in a bit of financial juggling. They’d borrow, say, 1,400 florins to buy a bulb and

then sell it later the same day for 1,500. This goes beyond easy money. It’s profit without

any investment whatsoever – something speculators call “leveraging.” Any old Dutchman

who woke up without a penny to his name could take out a loan in the morning, buy a

tulip at noon, sell it for more in the afternoon, pay off what he owed plus interest, and go

to sleep having turned a nice profit.

Edward Chancelor, The Devil Takes the Hindmost (Rio de Janeiro: Companhia das

1

Letras, 2001), p. 30.

You could even make a living that way. And still can. In fact, that’s how banks

make money even today. They borrow at least three times what they have and invest it.

Then they pay it all back and hit the sack having made a profit. Lehman Brothers, the

biggest U.S. investment bank until 2008, borrowed up to $30 billion for every $1 billion it

had in hand. It’s like someone who has an income of $30,000 borrowing a million every

year. Paying all this off and going to bed richer isn’t for everyone – not even for Lehman,

which collapsed, dragging the world economy down with it. But that’s a story for chapter

13.

For now, let’s jump back to the flower bed. Speculation on tulip bulbs kept

growing, with their price following suit. At the height of the boom, in 1636, Semper

Augustus jumped 200%, from 2,000 to 6,000 florins. Cheaper flowers rose even more.

The more common Gouda tulip skyrocketed from 20 to 225 florins – an increase of over

1,125%.

The tulip market had caught fire: if you purchased a bulb note, whatever the

price, someone would always come around to buy it for more. But a fire doesn’t burn

forever. “Just let it be eternal as long as it lasts,” the speculators prayed. It wasn’t, and it

didn’t.

This market could only sustain itself if prices kept rising forever. But the

values involved no longer had anything to do with the actual demand for flowers

as a luxury item. There were not that many noblemen prepared to spend the

price of a mansion to show off a little flower to their friends. The number of

such people is a finite resource. At that point, there was no longer any real end

consumer. Folks simply bought the notes for extortionary amounts in the hopes

that an even bigger sucker would come along later, ready to pay even more for

them. But suckers are a finite resource as well. At some point there just weren’t

enough buyers.

To make matters worse, major fraud was uncovered: florists were selling

more contracts than the number of bulbs they had in stock. It was like printing

counterfeit money. What’s more: nobody knew that a virus was responsible for

Semper Augustus (nobody even had a clue what a virus was, since microscopic life

was unknown back then). If the virus didn’t infect the bulb, a normal tulip would

bloom. And the investor would see that he’d bought a pig in a poke. When this

became public, distrust took over. And the market dried up. For good.

Anyone who had sold their house and carriage to invest in easy tulip

money found themselves with their hat in their hand overnight. The contracts

had turned into “toxic assets,” as economists say. They were worthless. The

government had to step in, pardoning the debts of those who had gone bankrupt.

And the economy would take years to get back on its feet.

For anyone who followed what happened to the economy before, during,

and after the 2008 crisis, all this sounds familiar. In the investment world, the

early years of the twenty-first century were as euphoric as the era of the tulip

rage. In fact, a good number of stocks went up as much as those flowers did 300

years ago. Without exaggeration, in the three years prior to the crisis, shares in

Brazil’s Vale – the second-largest mining company in the world – rose almost as

much as Semper Augustus during the three peak years of the Dutch bubble: 200%.

Stock in the Brazilian steelmaker Gerdau shot up like Gouda tulips: 1,000%. And

the shock wave didn’t hit only those who operate directly on the market. In the

year 2000, the Brazilian government set up a program that allowed workers to

transform part of their Government Severance Pay Fund (Fundo de Garantia de

Tempo de Serviço, or FGTS) into stock in the state-owned oil concern Petrobras.

The 312,000 Brazilians who opted to do so that year saw their money bear fruit.

If you allotted, say, $25,000 of your FGTS fund to invest in this stock, you ended

up with over $250,000 in your account by 2008, and with less effort than if you’d

earned the money on “Big Brother” – or in seventeenth-century Holland.

The difference is that this wasn’t a game between conmen and suckers.

Corporate profits were rising at the same pace as stock prices, sometimes even

faster. Making everything much more concrete.

If you hold one share of the mining company Vale, for example, it means

you own 0.2 billionth of the business. As part owner of this mining company, you

have the right to a piece of its profits, or “dividends,” as they’re called. And this

money trickles into your account every so often. That’s the point of stock: paying

out dividends.

If profits are high, the money you earn will be sizeable as well. Owning

these shares is good business when the company is profitable. So good that

other people will want to buy them from you so they too have the right to receive

a slice of the company profits. That’s the law of supply and demand: if lots of

folks are interested in the stock, its price goes up. And you can sell it on the

market for more than what you paid. Elementary.

That’s another thing stock is good for: profiting on someone else’s

expectations. Theoretically, the buyer is someone interested in holding shares

so that the cash from the dividends will go into his account. But since there are

so many people in the market, the typical buyer is in actual fact someone who’s

simply expecting to sell the stock for a higher price in the future, just like on the

tulip market.

Earnings on the buying and selling of stock can be so great that the

market virtually revolves around them. Almost everyone who buys shares in a

company does so in hopes of selling them at a profit some day. People end up

seeing dividends as a perk, just a little money that comes in once in a while.

What’s really at the heart of the matter is the expectation that these shares

can ultimately be sold for two, three, or ten times more. But this is a reversal of

values that just muddies the waters when it comes to understanding the logic of

the stock market.

To start with, what drives the price of a stock up? The obvious: the more

people interested in a stock, the higher the price it will catch on the market.

Logical. But what prompts large numbers of people to decide to buy shares in

a particular company, pushing prices way up? The company’s profit potential.

The more a business makes, the greater its ability to pay out fat dividends. In

other words, dividends aren’t merely a perk. They’re the essence of the financial

market. If a company is expected to produce more profit and pay better dividends

down the road, more investors will be enticed to buy its stock. And the price will

go up.

But there’s a problem here: expectations are merely expectations. Nobody

can tell if a company will profit more or less in the future. And if a corporation

starts wallowing in the red and from there slides into bankruptcy, the fate of its

shares will be the fate of those tulip notes: they’ll be worthless. It’s because of

this uncertainty that the financial market is rife with analysts who are paid to

study the financial health of corporations. They scrutinize balance sheets and

sniff through the market in search of any clues about a company’s ability to

continue ringing up a profit. Yet even that’s not enough.

For example, would you buy stock in a company that increased its

earnings from $13 billion to $100 billion in five years? Continuing with this

scenario, imagine that the same company swore up and down that it would soon

double this $100 billion – “soon” meaning next year. Add the fact that it’s as large

and apparently as sound as a company like Vale. Not buying stock in a business

like this would be like throwing your money away.

And this company existed: it was Enron, the biggest American energy

company of the late twentieth century.

After multiplying its earnings nearly tenfold, it landed in the comfortable

position of the corporation with the second highest earnings in the world,

outranked only by Exxon Mobil, the largest oil concern on the planet. There could

be no safer investment. It was the corporation responsible for lighting up a good

portion of the biggest economy on earth. The only way it could not make money

was if Americans gave up power and decided to live off the grid.

This is precisely why energy companies usually guarantee a constant

inflow of dividends. They’re almost risk-free. In fact, when times are tough, a lot

of folks go after this kind of stock. For example, when Bovespa – the São Paulo

stock exchange – was going through a meltdown in the 2008 crisis, shares in a

number of energy concerns remained safe and sound.

Of course, if this were the only question, everybody would invest in

nothing but energy companies. There’s something else though. While this stock

may guarantee dividends come economic rain or shine, on the other hand, its

value rarely goes up much.

These companies’ profit potential is limited to people’s energy

consumption. And this never leaps overnight. So expectations about profits are

never overly optimistic. They’re always so-so, lukewarm. And stock prices never

shoot through the roof overnight. If you hold stock in Petrobras, for instance, and

the firm announces that its pre-salt fields contain twice as much petroleum as

predicted, its profit potential will skyrocket, pulling stock prices along with it. It’s

virtually impossible for something like this to happen with a power company.

That’s what makes the Enron case special. If a huge energy company

like it starts racking up absurd profits, it’s a perfect world: a stock that has an

incredible potential to rise and no way of coming down.

It was too good to be true. But it was true. As to be expected, the stock

soared. And once again, almost at the same pace as Semper Augustus, queen

of the tulips: 200% in three years. From 1999 to 2001, one share in Enron went

from $30 to $90.

Good for the investors who bought the stock. Better yet for Enron

executives. They received tons of these shares for free as part of their annual

bonuses. A well-deserved reward, you might say, if you consider that Fortune

magazine named Enron “America’s Most Innovative Company” six years in a

row.

After its stock value tripled, some company executives did what anyone

would do: they sold the hundreds of thousands of shares they had received as

bonuses, pocketed the profit, and set off to enjoy the good life.

One of them was Lou Pai, a Chinese-American. He was a top executive

at Enron when he decided to retire at 52. Lou received $268 million in one fell

swoop and went to live quietly on a 77,500-acre ranch in Colorado – the second

largest piece of property in the state. He had a smaller parcel in Texas too, for

his stud farm.

A more than happily-ever-after end to his career. Except that the story was

far from over. For those who had bought stock in Enron, it was just beginning.

A little over one year after the value of an Enron share reached $90, the

company went belly up. And whoever had wagered his savings in it as well.

Wiped out. An investment that was supposed to be risk-proof – and that had

made a lot of folks wealthy – had proven a bust. What had happened?

A crime. The corporate executives had lied about the company’s profits.

They recorded false amounts on their balance sheets to guarantee their own

profits in the form of performance bonuses. But eventually the authorities who

oversee publicly traded companies spotted the fraud. They recalculated the

balance sheets and found that Enron was in the red.

The news spread and the stock tanked, dropping almost to zero. And in a

matter of months it did hit zero. Enron filed for bankruptcy. The tulip was dead.

This was an extreme case, where escalating stock prices were backed by

a lie. And where a company closed its doors in the end. But similar situations

occur on the market all the time. It doesn’t take fraud to drive a stock up much

higher than it should go. All it takes is exaggerated expectations about possible

future profits. Most of the time, in fact, irrationality is the rule, not only in regard to

each single company but to the whole market. Hundreds of companies can see

their stocks rise simultaneously because of unrealistic expectations. If there are

big hopes that the economy will grow, for example, this will be felt on the stock

market. Of course: a good economy offers more jobs. More jobs means more

consumers. More consumers means more chances for companies to profit. Then

stocks rise and…

Hey, wait a minute! First, what exactly constitutes a “good economy”?

Second, is a world with a lot of jobs, a lot of consumption, and a lot of profit for

lots of people the cause or consequence of “a good economy”? There’s only one

answer: “Yes.” An alright world is cause and consequence of an economy that’s

alive and kicking. But to understand exactly what this answer means, you have

to understand something else: what money is.

That’s something the chimpanzees can explain. Let’s see what they have

to say.

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