Search

Forever blowing bubbles - the economics of beauty.

“How can you be content to be in the world like tulips in a garden, to make a fine show, and be good for nothing.” Mary Astell

 

At the end of winter, 1637, the price of tulips in the Dutch Republic collapsed. The economic powerhouse of the 17th century was shaken to its foundations. Unexpectedly, the country who boasted the biggest corporations in modern history suddenly had a bleak economic outlook on the future. How a mortal flower became the undoing of the Dutch economy became one of the greatest lessons humans in society have learnt, mainly due to how ridiculous the idea is in retrospect. So, why does the fallacy of beauty recur with such frequency?

An economic bubble is defined as when the price of an asset deviates from its intrinsic value. The price rises so much that the asset itself becomes inherently risky, weighed down by the expectation of exponential price increases. Inevitably the bubble pops, and the aftermath is often destructive. Failing to take the early exit from the primrose path leaves you in the rose bushes. This leads me to the art market. Does it fit the characteristics of an asset price bubble, and will it lead to great financial loss? Only time will tell.


The art I am talking about is the type where oil pants are lathered onto canvases of the highest quality. They often are reproductions of real-life models, like influential people or beautiful stretches of land. They are, in essence, a concept not far removed from an elegant flower; a tulip perhaps. The beauty on their surface is easily recognisable, but does that beauty justify such high price levels? It is arguable that it does not, and that art is a bubble just as ludicrous as the market for tulips.


Tulips were first introduced into Europe from the Ottoman Empire (modern day Turkey) in the mid-1500s. Their vivacious colour and shape made them an immediate must-have for European aristocrats. Trying to be a prevalent member of society without a flowerbed containing tulips was like trying to ‘win the Indy 500 riding a Llama’, to quote Michael Lewis. The wide variety of bulbs available due to germination and mutation therefore created a diverse market where inferior products that were perceived as ‘lower quality’ were less valuable and rarer flowers like the Semper Augustus were the most valued. Nothing revolutionary. In this basic mechanism, the flowers did not inflate to catastrophic prices. They were still high, but not high enough to become unsustainable. Then speculators entered the market.


Growing demand for Tulips from neighbouring France caused profit-driven speculators to step in. The year of 1634 came to be the turning point. Contracts that gave buyers the right to sell tulips at a future date were introduced, lighting the fuse for the frenzy to begin. The contracts were not too dissimilar from the ‘futures’ contract of today; the holder of a contract had the right to sell tulips in the future in the hope of a higher price and a greater return. Thousands upon thousands of traders rushed to get their hands on such contracts in the expectation that prices would riser exponentially. They did indeed rise up until the end of winter, 1637, when prices collapsed.


The collapse is purported to have begun in Haarlem (where the NYC neighbourhood of Harlem gets its name), when contracts traders didn’t show up for the daily contract auction; contracts would often change hands up to ten times in a day at these auctions. It is crucial to remember the context of the time period. Haarlem at the time was experiencing an outbreak of bubonic plague, and caused trading to cease in one area whilst in continued in others. This knock-on effect is reminiscent of the sub-prime meltdown of 2008, where mortgages in the ‘bottom’ tranches of mortgage backed securities defaulted, destabilising the bond and causing further defaults. Eventually the bonds became worthless, just like the tulips. Investors saw through the esoteric and convoluted networks of buyers and sellers and realised their intrinsic values. Close to worthless.


The principles of these bubbles can be related to a simple home truth. If something seems too good to be true, it normally is. The art market may just sync with the parable of the tulip and its faulty market mechanism. The second speculators step into the art market may be the very its shaky foundations are irreversibly damaged. When the prices of assets are increased, further appreciations are anticipated; this lifts the price of artwork higher. As soon as owning a Van Gogh is labelled ‘profitable’, the sooner it becomes a devastating bubble phenomenon. To this end, it is arguable that the art market is in need of regulation.


Nouriel Loubini, a world leading economist, argues that the art market needs exactly that. He predicted the 2008 ‘mortgage meltdown’, and has turned his interest towards the art market. He references the price manipulation, insider ‘trading’, and money laundering. This causes an inherently unstable market environment. Loubini argues that in order to guarantee the longevity of art, a stricter set of controls are to be put in place to create an inherent stability not perceptible in current market conditions. This would prevent speculators from interfering and pushing prices to unrealistic levels; it is key to deter people of regular means entering markets and falling victim to the actions of their fellow, morally inferior, market participants.


To conclude, I will leave you with the words of John Updike. “What art offers is space - a certain breathing room for the spirit”. that is the key message. Let us appreciate art, not taint it with murky morals and a desire to profit from those around us. A shared resource, not a scarce and disputed one.

18 views0 comments