How Tulips Affect Economies – Why Economics History is Important

We have seen recently that a sudden change from excess demand to excess supply is devastating to the economy. The effects of overpayment for commodities resulted in the recent economic woes, the tech bubble a few years back and the disastrous economic events of 1929.  The bursting of economic bubbles goes way further back than we realize as shown by the events below.

 

Tulip Economics

 

Prices skyrocketed as demand for a future product soared (demand was inelastic in economic ‘speak’). The product was Tulips and the momentum of demand was like a huge tidal wave growing exponentially. Contracts were taken out for future crops of various derivatives of the beautiful Tulip flowers and bulbs.

 

Tulips, it is known, are not fast growers; it takes over seven years to grow flowering plants from bulbs or seeds however the rarest tulip, the multicoloured variety, only grows from a bulb. The multicoloured Tulip therefore was highly sought after, far more than it’s red, yellow and other single colored namesakes.

 

Demand Goes Crazy

 

The escalating prices were as a result of classic supply and demand economics. Supply was fixed due to the extensive time needed to grow the product whilst demand grew due to fortunes being made. The fortunes were made mostly because of the speculative nature of the future contracts. Tulips, the product, are seasonal and were only physically available for ownership transfer for a few short months each year. Because demand was high, and rising, the contracts could be sold for a higher price than the purchase price of the product itself. The contracts were eventually a product of their own accord and were traded and priced in line with booming demand.

 

Economic History Repeated

 

As we have seen recently, when demand is affected or finance becomes scarce, the market collapses. This is exactly what occurred in the Tulip market; very quickly demand plummeted and holders of the contracts for the Tulips were unable to sell the contracts which they had purchased for way more than the product was worth. The economic impacts were devastating and widespread.

 

The above events occurred four centuries ago, in February 1637 to be exact. The event became known as ‘Tulip Mania’ and resulted in the near collapse of the Dutch economy, where Tulip Mania began.

 

Isn’t it odd that we are still surprised when excessive speculation results in collapsed economies! Excessive overpayment and trading in overpriced products is called a bubble. Bubbles burst!

Economics Book Review – The Ascent of Money, a Financial History of the World by Niall Ferguson

Cryptocurrency is a digital asset used mainly as a medium of transaction to secure financial transactions, control creation of additional assets and verification of any asset transfers with the help of a strong cryptographic technology. It is also known as a form of digital currency or virtual currency. Unlike central banking systems, it is a decentralized control and financial transaction system that works through a blockchain used mainly for financial transactions.

The first decentralized virtual currency to be developed in 2009 is Bitcoin known as a virtual monetary unit and it works independently without the assistance of any central bank or administrator. Since then, around 4000 altcoins of diverse variants of bitcoin have been developed. Bitcoin is considered as a peer-to-peer electronic cash system where users perform transactions directly without any intermediates.

Blockchain is a data file consisting of numerous blocks that keeps records of all the previous bitcoin transactions and also creation of new ones. The normal average time between each block is around 10 minutes. The most frequent use of bitcoin, is supported by an external software named Bitcoin wallet. By using this software, one can easily store, receive and manage the transaction of bitcoin units. In order to perform transactions using bitcoin, one needs to have an account in any one of the bitcoin exchanges across the globe and has to transfer fiat currency into that account. Thus the account holder can perform future transactions by using these funds. Apart from the bitcoin, some of the other sources of cryptocurrency is petro which is mainly used for oil and mineral reserves.

There are some pros and cons associated with the usage of digital currency. The main benefits of using a virtual currency are as follows:-

• Provides a quick transparency layer:-

The Bitcoin usually operates with the help of a ledger called Blockchain that records & monitors each and every transaction. Once when a transaction is made and is recorded in this ledger it is considered to be as static. These transactions can be further verified at any time in the future and hence in addition to this, it also ensures security and privacy regarding all the transactions made through a particular account.

• Fast Processing and Portable Usage:-

Billions of dollars of bitcoin can be easily transferred from one location to another without any detection with the help of a single memory drive. While performing any kind of transactions, involvement of any third party can be eliminated by using this bitcoin technology. This will result in an easy and rapid transaction without any approval from a third party,

• Low transaction costs involved:-

Transaction costs involved in the exchanging of these digital currencies is very less which makes it more affordable than the real currency for the population across the world. Hence, cost of any kind of transaction made is very less which turns out to be an advantageous feature for the population whenever they are performing any transactions.

• Combats & eradicates poverty:-

Often the banking systems and financial institutions do not provide help or assistance especially to backward classes in rural areas. Bitcoin serves as an alternative in such cases where it extends its robust financial services to anyone with internet access. It often serves as a support for poor and oppressed classes who are in most cases not given any viable alternative.

As and when a new or latest technology arrives, there are some negative factors also associated with its usage which are as follows:-

• Lack of knowledge and mistrustful approach of the population:-

Due to lack of knowledge regarding digital currency people are more likely to become mistrustful of its widespread use. Hence, there are only very few number of business systems that accept these sources of cryptocurrency therefore limiting the business systems who prefer to use the virtual currency in their daily transactions.

• Non-traceable transactions:-

Since, transactions made by bitcoin are untraceable it provides a room for criminal transactions. In such cases, drug dealers and scrupulous persons are the ones who make use of such virtual currency so that their illegal activities are not detected easily.

• Volatile and Uncertainty nature:-

The cryptocurrency is at times volatile and keeps on changing frequently on a large scale. Sometimes people make quite a amount of money when the market rates of these virtual currencies are skyrocketed and at times they also face great loss when the price crashes.

Cryptocurrency is an innovative but amateur concept that can potentially disrupt the whole financial market. It is true that this digital currency has grabbed the world’s attention in a short span of time. There are always benefits and drawbacks to every new technology that arises in the market. In order to make the best use of it, one needs to look into both sides before making any decisions.