97 Years After Black Tuesday, Are Investors Making the Same Mistake?
It is an odd fact that 100 years after the Great Crash of 1929 and the ensuing Great Depression, no satisfactory and certainly no agreed explanation for these events has been arrived at.
My father's book, largely written from newspaper accounts at Dartmouth in the summer of 1954, was the first history focused on the Crash. Up until then, the turbulence of the Depression, the New Deal and the war had absorbed scholarly, popular and political attention, and the drama of October, 1929 was beginning to fade in memory. The Great Crash 1929 assured that it would not.
By placing the Crash front-and-center, my father could tell a fine tale of financial folly, replete with chicane and rooted in the almost-innocent all-American desire to get rich without really working. It is a motif with many antecedents and also many recurrences. The elements of exuberance, hubris and comeuppance – just or not – tie financial markets to the larger human experience. And this humanizing approach has been followed by others who have since tackled the theme; Charles Morris and Andrew Ross Sorkin notably come to mind.
To the extent that a theory has been built around the Crash, it is Hyman Minsky's “Financial Instability Hypothesis.” The story is of phase transitions in the structure of debts – hedge, speculative, Ponzi – similar to the transition of water from ice to liquid to steam as temperature rises. Stability breeds instability, Minsky wrote, and episodes like the Crash are endemic to capitalism; the dynamism and the fragility are inseparable parts of the same beast. Benoit Mandelbrot's “multifractal generator” of financial prices conveys the same message. The system generally delivers gains, but the same process can, with utter unpredictability and no warning, deliver a colossal blow that takes them all away.
A second relevant – though highly inconvenient and therefore, studiously neglected – concept is William K. Black's “control fraud,” defined as (what else?) fraud committed by those in control. Control fraud is collapse by design, or bankruptcy for profit as George Akerlof and Paul Romer described it. The canonical case was the Savings and Loan debacle of the 1980s and 1990s, when deregulation facilitated the criminal takeover of major institutions, notably in California and Texas, protected for too long by their political friends. For those watching closely, the detection of control fraud can make collapses predictable in certain situations, such as those leading up to the Great Financial Crisis of 2007-2009. This is why the Big Short, chronicled by Michael Lewis, could occur.
These narratives and their associated theories focus attention on financial processes and financial markets. Such processes and markets have, in this construction of the nature of things, a life of their own. They are detached from something called the “real economy” and can, it seems, be analyzed without reference to specific legal systems, cultures or technologies. The approach universalizes financial instability, so that any one such episode becomes more-or-less comparable with any other, going back to the Dutch tulip craze of the late 17th century and forward to the current moment with artificial intelligence and data centers.
The comparability of financial debacles is captured, but not explained, by the physical metaphor of the bubble. That metaphor conveys, in a single image, both the steady inflation and the abrupt collapse – a certain denouement at an unknown time. Yet the metaphor substitutes for thought; it obscures the fact that there is no cause-and-effect explanation for either one. And there is no method for distinguishing a bubble from something else, amenable to that other deceptive metaphor, the “soft landing.”
The Crash and the Depression
What then is the relationship of financial instability to the so-called “real economy”? In particular, how did the Great Crash relate to the Great Depression?
The Depression is not the central focus of The Great Crash 1929, and my father gave only a cursory survey of five inter-related causes. These were a bad income distribution, a bad corporate structure (meaning too much leverage), a bad banking structure (meaning no deposit insurance), a “dubious foreign balance” (meaning vulnerability to debt default), and the “poor state of economic intelligence,” meaning the pre-Keynesian commitment to balanced budgets. The implication, one supposes, is that if these matters had been dealt with during the 1920s, the Depression might not have occurred. But then, the 1920s would not have been the 1920s. I would not lean too heavily on such a view, and I don't think my father would have either. The fact is, he didn't feel it necessary to explain the Depression in this short and focused book – and so far as I know, he didn't do it elsewhere.
My father did believe that the Crash helped to kick off the Depression; otherwise he might not have written his book. But on this point, mainstream economists have disagreed. For the dominant school of modern economics, the Crash could not have “caused” the Depression or even influenced it. For this school, the market economy is inherently stable or self-stabilizing, and the financial markets are only indicators of the underlying drift. To affect the “real economy,” something must hit the real economy, as it were, from the outside. Some kind of “shock” is necessary. Some economists have also argued that the slump was underway before the Crash, so that the stock market becomes an incidental effect, rather than a cause, for the dark years that followed.
A Brief Survey of the Chattering Economists
The mystery of the Crash and the Depression has given risen, over a century, to many mutually inconsistent views [1].
John Maynard Keynes, writing in 1930, argued that the very distinction between “financial” and “real” was untenable, misleading and beside the point. The collapse in the stock market was a collapse in profit expectations – a profound change in the social psychological foundation of business capital investment. Without expectation of profit, business investment also collapsed, and without the flow of investment, so did the aggregate demand for output. Thus Keynes could argue that the remedy was to increase effective aggregate demand by whatever means might be available, notably public expenditure and public works. This was the essence of Keynesianism: you don't need to reverse the cause to effect the cure. But Keynes gave no very specific reason for the collapse in profit expectations, and his latter day followers (notably, George Akerlof and Robert Shiller) throw up their hands and repeat his reference to “animal spirits [2].” But is capitalism really subject to massive collapse on no precipitating grounds at all? And if so, why was the Great Crash such a rare, indeed practically unique event?
Milton Friedman and Anna Schwartz, writing in the early 1960s, blamed the Federal Reserve for not preventing the collapse of the money supply, and by extension the collapse of the money supply for the Depression. This interesting argument disconnected the crash from the Depression, and supposed (without establishing) that the power to prevent a crash of the money supply rested with the Federal Reserve in the first place. But it flowed from Friedman and Schwartz's prior belief in the natural stability of the private economy, and therefore by construction the responsibility of government for any failures that might have occurred.
Charles Kindleberger, writing in 1973, stressed the weakness of the international monetary system, in the process of transition away from the hegemony of sterling but having not yet arrived at the hegemony of the dollar. Barry Eichengreen follows in and largely develops this tradition.
Peter Temin, writing in 1976, sought to critique Friedman and Schwartz, by then the dominant view among academic economists. Temin followed Keynes in stressing demand, but with the modification that he rooted the drop in demand in a shift of the consumption function, ostensibly exogenous and not itself easily explained. Did something happen to the American household in the late 1920s, not seen before or replicated since?
Jude Wanniski, writing in the mid-1970s, blamed the Smoot-Hawley tariff, an argument with a bit of support in these pages, which note that the tariffs helped precipitate Peruvian debt defaults, which helped undermine confidence in the banks that had made those loans. But this was not Wanniski's mechanism; for him the essential offense was the sacrilege against free markets and free trade.
Ben Bernanke, writing in 1983, blamed a rise in “uncertainty,” and this argument was largely recapitulated by Christina Romer in 1988. Their argument linked the Depression to the Crash, but left the crash unexplained, as either an exogenous shock or something endemic to the financial markets. Bernanke focused on investment spending, while Romer added the dimension of consumer durables purchases. She writes that “the stock market crash caused consumers and producers to become uncertain about the course of future income.” (emphasis added).
I need not comment on some of the more recent work, dating to the 2000s, that blames the Depression on the New Deal, including on the price-fixing efforts of the National Industrial Recovery Act and the crop reduction programs of the Agricultural Adjustment Administration. This work conveniently places responsibility for events in 1929, 1930, and 1931 on policies enacted in 1933, a true feat of rational foresight. Indeed it has become somewhat fashionable to argue that the New Deal was entirely counterproductive, inhibiting the natural recuperation that would otherwise have occurred [3].
Meanwhile, for acolytes of the “real business cycle,” the Depression was normal, not anomalous, and therefore not an event that justifies the concern with which it has come to be viewed. Cycles happen thanks to the ebb and flow of technologies. Applied to this instance, the doctrine specifies that “total factor productivity” fell, and the rest followed. Yet total factor productivity is a vague notion, and no specific asset or specific technology appears to be associated with this idea. This led even so dedicated a “new classical” as Robert Lucas to remark in 1994, “What technological or psychological events could have induced such behavior in a large, diversified economy? How could such events have gone unremarked at the time, and remain invisible in hindsight?” A very sensible question.
In short, what a mess! Though some of it is plainly nonsense, the above list is not entirely wrong. It includes proximate causes, contributing factors, spurious correlations, and also empty, irrefutable assertions based on unobservables, such as Larry Summers' 1986 remark that “What happened was a failure of the exchange mechanism.” What there isn't, is a clear-cut precipitating event, that might explain both the why the stock market crashed when it did and why capital investment collapsed, why the banks collapsed, and why demand and finally production also collapsed. It seems we have a better view of the extinction of the dinosaurs, the fall of Rome and the collapse of the Maya than our economists have given us of the defining economic events of the last century.
But suppose there was a precipitating event? Suppose we just missed it, because we did not understand the underlying economic processes that could turn such an event into a disaster?
Basics of Entropy Economics
All life requires resources, which must be extracted from the environment, with a sufficient surplus so as to make it possible to work, develop, grow and reproduce. And this is no less true of any mechanical system, or of any economy. Access to resources requires energy, which comes in the first instance from sunlight, or from its stored forms, including wood, coal, oil, natural gas – as well as the nuclei of certain very heavy atoms. To get at the energy requires tools, which are built according to plans, and at increasing levels of complexity as technologies advance. But complexity is a two-edged sword. It permits ever-greater efficiency in the use of resources, thus ever-greater levels of production and the improvement in human life – but it induces fragility in the system as a whole. Once a system is built, it functions in a certain, predictable and predetermined way, so long as the conditions for which it was designed hold good. But those conditions may change. Simple systems are robust; complex ones are prone to major breakdowns and disasters.
Economic value arises because that which is necessary, or desired, is often scarce. And this is particularly true of goods or services that are newly created, imagined, or packaged in such a way as to appear to be new. Innovation is by definition recent, and by definition has a single originator. Innovation is usually achieved by introducing a new level of complexity, as well as other improvements of design or recombination of existing technical forms. During the window, however brief, when imitations are few, the originator enjoys a degree of market and monopoly power, enhancing the economic value associated with the scarcity of the innovation. This is the moment when fortunes can be made. And economic life is dominated by the search for fortune, arising from producing that which is new, better, or made more cheaply but just as well, than that which already exists.
These are the basic elements of what Jing Chen and I, in a small book published in 2025, have called “entropy economics.” Our goal was (and is) to bring economics into alignment with the understanding, now prevalent in every other field of human inquiry, of the second law of thermodynamics – the entropy law – which is the most fundamental law of nature. We believe that this is the key to understanding that there was, in fact, a precipitating technological event behind both the Great Crash and the Depression.
For mainstream (neoclassical) economics, technological change is a largely continuous process, with phases of acceleration and deceleration. It cannot make things worse. That is why mainstream economists are relentless techno-enthusiasts – they see the dynamism of capitalism as its principal justification, in the face of inequalities, environmental degradation, and the working population's native suspicion of the capitalist class. Joseph Schumpeter, a conservative but definitely non-mainstream observer of the 1930s, took a much colder and more clear-eyed view, summed up in the phrase “creative destruction.” Schumpeter's insight was that new technologies destroy older civilizations and ways of life, leading (he argued) to improvements for the survivors but not without severe costs for those invested in the previous systems and methods. Indeed for this reason peasant farmers and medieval guilds were by nature technologically conservative: they wanted to keep what they had and were not concerned about the great gains accruing later on to someone else. Schumpeter however, so far as I'm aware, did not specifically identify a new technology bridging the crucial moment in this story.
We believe that the precipitating event, in this instance, was the announcement of the discovery, in Texas, Oklahoma and California, of vast reserves of oil.
Oil and the American Energy Revolution
The Industrial Revolution, which began in Britain in the early 19th century, was a revolution based on coal, and on the application of coal to machinery powered by steam. Its first application was to pumps, increasing the efficiency and reducing the cost of extracting coal from the ground. It spread from there to metalworking, especially steel, and to the application of steel to transportation, through the railroads and then the ocean-going fleet, and (still later) to electrification. British power was coal power, as it remained well until the time of Margaret Thatcher and North Sea oil.
The United States followed the British path, though with greater reserves of wood and substantial water power as well, finding coal in Appalachia to power a rail system that by mid-19th century spanned the entire continent. By the first decades of the 20th century the railroads were the largest (and notoriously predatory) American industry, and their derivative demand supported the iron mines of Minnesota and the steel mills of the Great Lakes. When the Federal Reserve was created in 1913, two of its regional banks were located in Missouri (at St. Louis and Kansas City), reflecting the centrality of the rail network to both agriculture and industry in the American heartland.
By the second decade of the century, however, a new energy source was developing. Trucks are powered by oil, as are airplanes; both came into heavy use in the first world war, and as Thorstein Veblen observed, invention is the mother of necessity. In 1919 a colonel named Dwight Eisenhower set out to cross the continent with a motor convoy; it took 60 days to make a transit that could be done on the rails, by that time, in less than a week. A transcontinental highway was created (the Lincoln highway), though when my father drove it in 1930 to reach Berkeley from Cleveland, the road was unpaved from Lincoln, Nebraska to the California line.
The 1920s were boom years for the automobile industry, with production rising to 5,358,000 units by 1929, a figure, reported in The Great Crash 1929, that “compares very decently with the 5,700,000 new car registrations in the opulent year of 1953.” It was also a booming time for tractors, which were transforming American agriculture. Around one-third of American arable land in the late 19th century was used for forage, including heavily for horses that did most of the hard work in front of the plow. Tractors liberated that land, some for food crops, some for cattle. They also worked faster, and required fewer people. Agricultural productivity soared, outrunning the American ability to eat, and even to export. Any significant interruption in demand was likely not to end well.
Yet none of this necessarily had to end, least of all with a resounding crash, over a few days in October, 1929. Oil was available, but it was relatively scarce, and therefore expensive. Coal, steam, steel and the railroads enjoyed the efficiencies of a large, developed, complex infrastructure, around which American cities and factories had already been built. There were indeed also urban rail systems – the subways that still survive in New York, Boston and Chicago, but also streetcars that were allowing Los Angeles, San Francisco, Washington DC and other, relatively new and growing cities to expand. These ran on electrical cables that were powered by coal. There was good reason to expect this technological paradigm to endure – until, suddenly, there wasn't.
The key to the mystery has been found by Christopher Kennedy of the University of Victoria, British Columbia – an industrial/ecological economist with a strong record of research into climate and similar issues [4]. It lies not in any new invention, but in discoveries that changed the valuation of oil and therefore the prospective profitability of everything that ran on some other fuel. This was the discovery, in the late months of 1929, of vast new reserves in Texas, Oklahoma and California [5].
Specifically, as Kennedy found, on October 22, 1929, The New York Times announced that Standard Oil of California was cutting the price of oil by 50 to 75 cents per barrel, about 50 percent, “due to big overproduction”, with other majors expected to follow. Stock losses for the 23d were reported at $4 billion. The next day was Black Thursday, “the first of the days which history, such as it is on the subject, identifies with the panic of 1929 [6].” Then, on October 29, alongside $14 billion in losses on the 28th (“another terrible day”), the Times reported that Standard Oil of New Jersey would cut the storage of oil: there was more, readily available, than could be sold. The same day came Black Tuesday, “the most devastating day in the history of the New York stock market, and it may have been the most devastating day in the history of markets.” The Great Crash of 1929 had occurred.
But how could such a massively favorable development, the discovery of an essentially unlimited, high quality source of energy for every conceivable industrial, agricultural and home use – not to mention military – lead to a panic in the financial markets and a collapse of real activity? This is not something that the mainstream view of technical change can hope to explain! By all rights, what was found across the American West in 1929 should have led to an economic boom – to an explosion of productivity, production and prosperity. But it did not. Or to be more precise about it, it did not do so at once, and did not promise to do so for the immediate or even medium term future.
On the contrary. The problem is that the stock market captures the expected future profitability, not of the economy in general, but of the existing economic system. In 1929, that system was centered on rail, steel, coal and steam, and on factories built to use the system of transport and marketing that had been built around the great railroad corridors that came to span the North American continent after the Civil War. Suddenly, the future of that existing system was not merely in doubt. It faced an abrupt and certain demise, as coal declined and oil took its place. With no profit expectations there would be no investment, and without investment total demand would fall – just the sequence described by Keynes.
Why not just convert the rails to oil? Because the writing was on the wall, not just for coal-fired locomotives but for the railroad economy as a whole. And you cannot build a new economy based on cars, trucks and airplanes without roads and airfields, and refineries and pipelines and gas stations and fuel depots. These, as yet, did not exist at scale. And in 1929 it was very far from obvious that they would come to exist in the foreseeable future. Indeed, who would provide them? It is hard (even now) to make roads pay with tolls. And as the markets and activities declined, so did tax revenues and, therefore, so would the resources available to units of government below the federal level. Nor would the federal government step up, so long as those who ran it believed themselves constrained by the revenues they might be able to collect from taxes.
The path from Crash to Depression runs through the crisis of the banking system. The banks held assets of two very large types. One was mortgages on farm land and crop loans. These would fail as farmers could not unload their rising production at a profit. The ensuing foreclosures would put farm land on the market, cutting into the collateral of those who remained and deepening their ruin. And the other large-scale asset, held by banks, was the debts of the railroads. These too could not be honored. Banks that could not collect on either industrial or agricultural loans were at risk, and their depositors, once alerted to this fact, would not stick around. Runs ensured a large-scale contraction of the banking system. Bank failures doubled from 1929 to 1930, rose again in 1931, and peaked in the early months of 1933. After that, Roosevelt took office, took action, and the crisis eased.
The New Deal is remembered, in the then-contemporary literature and by most of the historians [7], mainly by the great rush of legislation that began with the Hundred Days: the Emergency Banking Act, Agricultural Adjustment, the National Industrial Recovery Act, the Public Works and Works Progress Administrations, the Civilian Conservation Corps, the Tennesee Valley Authority. These were followed in the Second New Deal by the Wagner Act and Social Security, and – after three decades, in Lyndon Johnson's Great Society, by Medicare and Medicaid. But there is more to it.
The Reconstruction Finance Corporation had been created under Herbert Hoover, with limited purposes. Roosevelt greatly expanded them, investing vast powers in Jesse H. Jones of Houston, Texas – a man who was intimately familiar with the rise of oil [8]. Jones set up the RFC in the regional branches of the Federal Reserve System and proceeded to fund waves of infrastructure investment relevant to oil: 600,000 miles of paved roads (paved mostly with asphalt), a thousand airfields, the Bay Bridge, Triborough Bridge, Lincoln Tunnel and more [9], including diesel-electric locomotives for the railroads [10] and an oil-fired aircraft carrier for the Navy. By the end of the 1930s the infrastructure was in place, the technological uncertainties had been resolved, and the path had been cleared toward the highways-and-suburbs economy that would flourish (for better or worse) from the 1950s to the 1970s.
An energy-entropy interpretation of the Great Crash, the Depression and the New Deal thus achieves what no other effort has been able to manage: it integrates all three events into a coherent whole, and ties the financial economy to the real economy. It is consistent with Keynes's core insight – a collapse of profit expectations leading to a collapse of capital investment – but without the seeming randomness of a purely psychological collapse of “animal spirits.” It shows why the private economy could not recover on its own, refuting the monetarist view of Friedman and Schwartz, and equally today's libertarians whose faith is in the self-stabilizing properties of private markets and reversion to trend of growth statistics. It shows precisely in what way the technical contribution of the New Deal was decisive in charting the path forward – whether one likes the oil-based economy that resulted is an entirely separate question. And it casts light on the crisis of the 1970s, when oil suddenly became scarce and expensive once again, and also on the recovery since 2009, when fracking restored the energy economy of the United States – for the time being.
Entropy Economics and the AI Boom: Lessons from the Great Crash
As the centennial of the Great Crash approaches, the United States is once again caught up in a boom, fueled by the artificial intelligence investments of the “magnificent seven” companies whose valuations now dominate the stock market. Many of the conditions identified by my father for the 1920s are readily recognizable: the bad income distribution, the bad corporate structure (leverage and concentrated power), a bad (highly concentrated) banking system, the dubious foreign balance – and, once again, a “poor state of economic intelligence.” By my father's lights, we should be all set, give or take, for a repeat of the Crash and an ensuing Depression.
What, then, about precipitating factors? In particular, what about energy, and what about the specific properties and characteristics of artificial intelligence and data centers?
At present writing, the energy economy is fraught with geological, geopolitical and technological unknowns. For the United States, oil and natural gas have been abundant since 2009 – quite unexpectedly so. Thanks to the advent of fracking and the high productivity of the Permian Basin, the United States has become once again the world's largest producer of petroleum and a major exporter of natural gas. How long this will last is a first unknown: the well count has been declining, and production may have peaked in 2025. The future of the price is a second unknown: in particular whether it will remain above the level required to encourage new exploration and more intensive drilling. The effect of such a price on every other form of economic activity in the country is a third unknown, though it is obvious that the American economy, writ large, runs on low oil prices.
What does not appear to be in the offing is the much-vaunted “energy transition” that will leave oil, gas and coal in the dustbins of economic history. It is true that substantial increments from wind and solar have been achieved, and a modest revival of nuclear power may be getting underway. But Jevons' Law, now more than 150 years old, states that for every new source of energy brought on-line, new uses also appear, and the end result is that all forms of energy are used, in ever greater quantities. Jevons' Law has not been repealed, and the world today uses more coal, oil, gas, hydro and nuclear power than it ever did before [11]. Periodically since the dawn of the atomic age, new forms of energy have been trumpeted as likely to undermine the fossil fuel economy in the same way that oil broke the back of coal after 1929. There is no obvious sign of any such thing in the near future.
Artificial intelligence appears on the scene, first and foremost, as a voracious user of existing energy and a competitor with all other uses for electrical infrastructure: power plants, transmission lines, transformers, and so forth. As such, it is a vector of cost inflation aimed at the heart of the American household, which lives in a home built for, adapted to, and reliant upon reliable, cheap electrical power. If, as seems likely, the boom in data centers outruns the growth of electrical supply, the only way to meet the demand will be to raise the price of electricity to all other users. This will deepen inequalities and increase the precarity of life for American householders, who cannot easily adjust their electrical consumption. In simplest terms, AI emerges as a competitor for the juice of life.
A second risk is that the AI boom will come to an end thanks to radical over-investment and over-production of a good (or is it a service?) for which there is insufficient economic use. This result would resemble the Internet crash of 2000, a shakeout that deflated the NASDAQ and drove a great many young and once-promising startups to the wall. But the Internet survived, and the associated infrastructure, though overbuilt at first, was eventually absorbed into the fabric of economic life. The recession of 2000 was not the Great Depression.
As artificial intelligence continues to develop, then one must ask, for what does it substitute? The answer is not far to seek: artificial intelligence is a cheap substitute for the real thing. Human intelligence is something that is cultivated slowly, at great expense, over time. It requires vast investment in fixed capital with limited alternative uses: schools, universities, libraries, training grounds, and more. In the neoliberal era, the predominant rationale for maintaining these institutions has been their contribution to the future earnings of the inmates, and their role in maintaining something called the “competitiveness” of the country. Both are undermined by AI. Perhaps the school and the university can be returned to their older roles as a form of luxury consumption good, in demand for their own sake in a society liberated from the pressures of routine mental labor. Perhaps, but it's not likely – the more likely outcome is that these institutions will shrink, and many will disappear.
There is yet another possibility. It is a possibility that comes closer to the 1929 scenario and to its consequences for the Depression. Suppose that something were to emerge that, all of a sudden, undercut the expected profitability of the entire AI sector, rendering the massive investment in data centers as stranded assets, like the steel mills of Youngstown or (still earlier) the textile mills of Lowell and Lawrence? And suppose, further, that that were something that emerged from outside the United States, so that it did not presage a later era of growth and prosperity in line with the new paradigm?
That possibility exists. There are hints of it already. They come, of course, from the People's Republic of China. Should it happen – and it could – that the Chinese outplay the Americans in the AI race – then everything that is solid (and well, nothing is) would turn to dust. Watch for it.
The collapse of oil prices and the collapse of stocks, 1929
Note that the oil news and the stock collapse reported on October 24 and 29 reflect events on the previous day. October 24 and especially October 29 were worse.
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