Wall Street Crash of 1929
The Wall Street Crash of 1929, also called the Great Crash or the Crash of '29, is the stock-market crash that occurred in late October, 1929. It started on October 24 ("Black Thursday") and continued through October 29, 1929 ("Black Tuesday"), when share prices on the New York Stock Exchange (NYSE) collapsed. However, the days leading up to the 29th had also seen enormous stock-market upheaval, with panic selling and extremely high levels of trading interspersed with brief periods of recovery.
Not only was the event of such a magnitude that it is unforgettable, the fact that economists were unable to predict it is in itself of great note. Although some well-known economists, particularly those of the Austrian School, were aware of the situation their warnings went unheeded. After the crash, the world sank into the Great Depression, with these two events inextricably linked in people's minds. Debate over the causes of the crash and this worldwide depression still continue, as economists and others seek not only to understand the past but to learn from them and thus to avoid a repetition of history. While safety measures have been instituted by the New York Stock Exchange and other stock exchanges to prevent a crash of such magnitude, it is change in the attitudes and actions of those involved in the world of finance and business that is needed to ensure that the suffering resulting from massive unemployment and loss of savings can be avoided in the future.
At the time of the stock market crash in 1929, New York City had grown to be a major metropolis, and its Wall Street district was one of the world's leading financial centers. The Roaring Twenties, which was a precursor to the Crash, was a time of prosperity and excess in the city, and despite warnings against speculation, many believed that the market could sustain high price levels (Smith 2008). Shortly before the crash, Irving Fisher famously proclaimed, "Stock prices have reached what looks like a permanently high plateau" (Teach 2007).
In 1929, so many people were buying on margin that they had run up a debt of six billion dollars (Allen 1986). "Buying on margin" involves borrowing money at a low interest rate (usually from a broker) to purchase stock, and then putting up the stock as collateral for the loan, expecting the stock price to go up resulting in dividends. Buying on margin has the effect of magnifying any profit or loss made on changes in the stock prices, but it allows individuals to make purchases without having cash to support them. In short, the bull market on Wall Street that began in 1923 led to an unprecedented period of share trading: "Excessive speculation was creating inflated wealth and a sense of prosperity built upon borrowed money" (Geisst 2004).
However, by 1929 there were signs of instability. On September 3 the Dow Jones Industrial Average (DJIA) reached its peak, closing at 381.7 (The Guardian 2008). The prosperity could not last forever, though. During the month of September, and despite the peak on the Dow Jones on September 3, the market was dropping sharply only to rise and then drop again. It was like tremors before a major earthquake but nobody heeded the warning. The market had sagged temporarily before, but it always came back stronger (Allen 1986).
In the days leading up to Black Tuesday in October, the market was severely unstable. Periods of selling and high volumes of trading were interspersed with brief periods of rising prices and recovery. These swings were later correlated with the prospects for passage of the Smoot-Hawley Tariff Act, which was then being debated in Congress (Wanniski 1978).
After the crash, the Dow Jones Industrial Average recovered early in 1930, only to reverse and crash again, reaching a low point of the great bear market in 1932. The Dow did not return to pre-1929 levels until late 1954:
Anyone who bought stocks in mid-1929 and held on to them saw most of his adult life pass by before getting back to even (Salsman 2004a).
Predictions by prominent economists
On September 5, the economist Roger Babson gave a speech in which he said "Sooner or later, a crash is coming, and it may be terrific." Later that day the stock market declined by about three percent, a phenomenon that became known as the "Babson Break." He had predicted a crash for years but this time the market fell (Allen 1986). The Great Depression soon followed.
In the summer of 1929, von Mises was offered a high position at the Kreditanstalt Bank. His future wife, Margit, was ecstatic, but von Mises decided against it. “Why not?” she asked. His response shocked her:
“A great crash is coming, and I don’t want my name in any way connected with it.” He preferred to write and teach. “If you want a rich man,” he said, “don’t marry me. I am not interested in earning money. I am writing about money, but will never have much of my own” (Margit von Mises 1984, Skousen 1993).
After Wall Street collapsed several months later, world trade suffered and in May 1931, Kreditanstalt went bankrupt. This, more than any other event, extended the depression throughout Europe.
Friedrich Hayek ventured, about the same time, similar dire predictions:
I was one of the only ones to predict what was going to happen. In early 1929, when I made this forecast, I was living in Europe which was then going through a period of depression. I said that there [would be] no hope of a recovery in Europe until interest rates fell, and interest rates would not fall until the American boom collapses, which I said was likely to happen within the next few months (Hayek 1975).
Timeline of the Crash
Spring and summer of 1929
In late March 1929, just after the inauguration of Herbert Hoover, the Federal Reserve Board met daily behind closed doors. There was no doubt heavy discussion about the market and the national economy. However, the May issue of the National City Bank of New York Newsletter indicated the earnings statements for the first quarter of surveyed firms showed a 31 percent increase compared to the first quarter of 1928. The August issue showed that for 650 firms the increase for the first six months of 1929 compared to 1928 was 24.4 percent. In the first nine months of 1929, 1,436 firms announced increased dividends. In 1928, the number had been only 955 and in 1927, it was 755.
The financial news was very positive in September 1929. The Dow Jones Industrial Average ("the DJIA" or "the Dow") reached a high of 381.17 on September 3. In September 1929, dividend increases were announced by 193 firms, compared with 135 the year before. There is evidence that many feared that it was overvalued—including the Federal Reserve Board and the United States Senate—although others have argued that this was not the case.
By 1929, there were many who felt the market price of equity securities had increased too much, and this feeling was reinforced daily by the media and statements by influential government officials. The market value of one segment of the market, the public utility sector, should have been based on existing fundamentals, and fundamentals changed considerably in October 1929.
- Thursday, October 3
Business activity news in October was generally good and there were very few hints of a coming depression. Although the start of the stock market crash is conventionally identified with Black Thursday, October 24, there were price declines on October 3, 4, and 16. The economic news after the price drops of October 3 and October 4 were mixed. But the deluge of bad news regarding public utility regulation upset the market, with the October 16 break following the news from Massachusetts and New York public utilities. Among the sensational and mostly negative “frantic stock selling news” news in, both, New York Times and Washington Post, there appeared the statement by Philip Snowden, British Chancellor of the Exchequer, that described America's stock market as "speculative orgy."
- Black Thursday—Thursday, October 24
On October 21, an amendment to impose tariffs only on agricultural imports was defeated. ... Three days later the stock market suffered its first one-day crash (Salsman 2004b).
On that day, October 24, forever called “Black Thursday,” 12,894,650 shares changed hands on the New York Stock Exchange (NYSE)—a record. To put this number in perspective, the previous record for trading activity was set on March 12, 1928. On that day, a total of only 3,875,910 shares were traded.
The market was crashing and the floor of the NYSE was in a state of panic. By noon on Black Thursday, there had been eleven suicides of fairly prominent investors.
- Battle to save the market
America's financial elite tried to rescue the market. At 1:00pm, several leading Wall Street bankers met to find a solution. The group included Thomas W. Lamont, acting head of Morgan Bank, Albert Wiggin head of the Chase National Bank, and Charles E. Mitchell, president of National City Bank. They chose Richard Whitney, vice president of the Exchange, to act on their behalf. With the bankers' financial resources behind him, Whitney placed a bid to purchase a large block of shares in U.S. Steel at a price well above the current market. As amazed traders watched, Whitney then placed similar bids on other "blue chip" stocks.
A similar tactic had ended the Panic of 1907, and this action halted the slide that day and returned stability to the market. However, recovery was only temporary. The move could not stem the tide this time.
- Monday, October 28
Over the weekend, the events were dramatized by the newspapers across the U.S. The Sunday, October 27 edition of The Times had a two-column article "Bay State Utilities Face Investigation." It implied that regulation in Massachusetts was going to be less friendly towards utilities. Stocks again went down on Monday, October 28. There were 9,212,800 shares traded (3,000,000 in the final hour). On Monday, October 28, 1929 the volume was huge-over 9,250,000 shares traded with a record 13 percent loss in the Dow for the day. But unlike Thursday, there was no dramatic recovery; it was the prelude to Black Tuesday, the most infamous day in Wall Street history.
- Black Tuesday—Tuesday, October 29
The Times on Tuesday, October 29 again carried an article on the New York public utility investigating committee being critical of the rate making process. Amid rumors that U.S. President Herbert Hoover would not veto the pending Hawley-Smoot Tariff bill stock prices crashed even further (Salsman 2004b). This time, the panic of selling made sure that there was to be no quick fix, and that the recovery would be slow and painful. The market had crashed.
The Crash led to higher trade tariffs as governments tried to shore up their economies, and higher interest rates in the US after a worldwide run on U.S. gold deposits. In America unemployment went from 1.5 million in 1929 to 12.8 million—or 24.75 percent of the workforce—by 1933, a pattern replicated around the world. It took 23 years for the U.S. market to recover (The Guardian 2008). While the Crash is inevitably linked to the Great Depression, the cause of that devastating worldwide situation go deeper than the Crash, which was in actuality only the "tip of the iceberg," a symptom of the problem. The causes of the Crash and failures to adjust in its aftermath combined to produce the Great Depression.
Some economists such as Joseph Schumpeter and Nikolai Kondratiev (also written Kondratieff) have claimed that the crash of 1929 was merely a historical event in the continuing process known as economic cycles. The Kondratiev long-wave cycle is a theory based on study of nineteenth century price behavior. The theory predicts 50-60 year-long cycles of economic booms and depressions (Kondratiev 1984). However, the stock market crash in 1929 was as monumental as it was unexpected. Thus, it falls far beyond the standard Kondratiev’s long-term economic cycles theory, which itself has been subject to serious criticism (Rothbard 1984).
Thus, although the K-cycle theory has economic merit, it cannot explain the 1929 Stock Market crash which occurred in the context of a variety of economic imbalances and structural failings. Thus the Crash is treated as a singularity (a unique event). These are some of the most significant economic factors behind the stock market crash of 1929:
Boom and bust
One possible explanation for the severity of the Crash in 1929 is that the preceding period was one of excessive investment—a great economic "boom"—which inevitably led to an equally excessive "bust." On this point, economists of the Monetarist and Austrian Schools are sharply divided. An interesting historical sidelight is the fact that Irving Fisher, the principal Monetarist of the 1920s, completely failed to anticipate the crash, while Austrian economists Ludwig von Mises and Friedrich Hayek predicted the economic crisis.
Monetarist Milton Friedman claimed, as he and Anna Schwartz concluded in A Monetary History of the United States, that the 1920s was the "high tide" of Federal Reserve policy, inflation was virtually non-existent, and economic growth was reasonably rapid. Monetarists even denied that the stock market was overvalued in 1929 In short, "everything going on in the 1920s was fine" (Friedman 1963: 240-298).
The problem, according to Friedman was not the 1920s, but the 1930s, when the Federal Reserve permitted the "Great Contraction" of the money supply and drove the economy into the worst depression in U.S. history: "I have no reason to suppose there was any over-investment boom … during the 1920s" (Friedman 1963).
- Austrian School
In contrast to Friedman and the Monetarists, the Austrians argued that the Federal Reserve artificially cheapened credit during most of the 1920s and orchestrated an unsustainable inflationary boom. The stock market crash of 1929 and subsequent economic cataclysm were therefore inevitable:
Up to 1927 I should have expected that the subsequent depression would be very mild. But in that year an entirely unprecedented action was taken by the American monetary authorities. … [they] succeeded, by means of an easy-money policy, inaugurated as soon as the symptoms of an impending reaction were noticed, in prolonging the boom for two years beyond what would otherwise have been its natural end. … And when the crises finally occurred, deliberate attempts were made to prevent, by all conceivable means, the normal process of liquidation (Skousen 1991).
Was there an overinvestment boom in the 1920s? The answer depends on which statistics you examine. The "macro" data favors the Monetarists’ thesis, while the "micro" data supports the Austrians’ view (Skousen 1995).
In support of the Monetarists, the broad-based price indices show little if any inflation. Average wholesale and consumer prices hardly budged between 1921 and 1929. Most commodity prices actually fell. Friedman and Schwartz concluded, "Far from being an inflationary decade, the twenties were the reverse" (Friedman and Schwartz 196, 298).
However, other data support the Austrian view that the decade was aptly named the "Roaring Twenties." The 1920s may not have been characterized by a "price" inflation, but there was, in the words of John Maynard Keynes, a "profit" inflation. After the 1920-1921 depression, national output (GNP) grew rapidly at a 5.2 percent pace, substantially exceeding the national norm (3.0 percent). The Index of Manufacturing Production grew much more rapidly and virtually doubled between 1921 and 1929. So did capital investment and corporate profits.
There was also an "asset" inflation in the U.S. A nationwide real estate boom occurred in the mid-1920s, including a speculative bubble in Florida that collapsed in 1927. Manhattan, the world’s financial center, also experienced a boom. The asset bubble was most pronounced on Wall Street, both in stocks and bonds. The Dow Jones Industrial Average began its monstrous bull market in late 1921 at a cyclical low of 66, mounting a drive that carried it to a high of 300 by mid-1929, more than tripling in value. The Standard & Poor’s Index of Common Stocks was just as dramatic-Industrials, up 321 percent, Railroads, up 129 percent, and Utilities, up an incredible 318 percent (Skousen 1995).
Yet, the Monetarists denied any stock market "orgy." Anna Schwartz suggested, "Had high employment and economic growth continued, prices in the stock market could have been maintained" (Schwartz 1997). Schwartz’s thesis is based on what appears to be reasonable price-earnings (P/E) ratios for most stocks in 1929 (15.6 versus a norm of 13.6). However, P/E ratios can be a notoriously misleading indicator of speculative activity. While they do tend to rise during a bull market, they severely underestimate the degree of speculation because both prices and earnings tend to rise during a boom.
However, if the increase in stock earnings greatly outpaces the increase in prices, the situation becomes unstable. In fact, during 1927-1929, the economy grew only 6.3 percent, while common stocks gained an incredible 82.2 percent. A crash was inevitable (Skousen 1995).
In sum, was there an inflationary imbalance during the 1920s, sufficient to cause an economic crisis? The evidence is mixed, but on net balance, the Austrians have a case. In the minds of the Monetarists, the "easy credit" stimulus may not have been large, but given the fragile nature of the financial system under the international gold standard, small changes by the newly established central bank triggered a global earthquake of monstrous proportions (Skousen 1995).
Overproduction was one of the main reasons for the Wall Street crash. During the boom, businesses were overproducing, making more goods than they were selling. New manufacturing methods, such as production lines allowed factories to produce more in a shorter amount of time. While demand remained high this was good, but in the mid 1920s the demand for goods began to decrease. Businesses continued their high rates of production, leading to overproduction. The result was a drop in prices, and a reduction in the number of workers, which increased the loss of sales. Unemployment rose, and the downward spiral was in motion.
In the 1920s, the agricultural sector in the United States began to have similar difficulties. Many small farmers were driven out of business because they could not compete in the new economic climate. Then, advances in technology increased production including overproduction of foods. However, demand for food did not increase at same rate as the increases in supply. Therefore, food prices fell and farms were unable to make a profit. Farm workers lost their jobs, increasing unemployment.
Weaknesses in the banking system
Before the Great Depression, the American banking system was characterized by having many small to medium sized banks. Thus, there were over 30,000 banks. As a result, they were in danger of going bankrupt if there was a run in which many customers wanted to withdraw their deposits. The agricultural recession led to problems with rural banks, which had a negative impact on the rest of the financial industry. Between 1923 and 1930, 5,000 banks collapsed. This clearly contributed to the economic instability that led to the Crash.
A more significant factor, though, may be inflation. For Ludwig von Mises of the Austrian School, inflation is defined as money creation, the act of which tends to manifest itself through the fall in the purchasing power of money (PPM). Thus for a given demand for money, an increase in its supply lowers the PPM.
Whenever monetary authorities allow the rate of monetary pumping to proceed at an accelerating pace, the purchasing power of money tends to fall by a much larger percentage than the rate of increase in money supply. Mises attributed this to increases in inflationary expectations. Peoples' expectation that the future PPM is likely to fall causes them to lower the present demand for money. This sets in motion a mechanism that, if allowed to continue unabated, can ultimately break the monetary system (Shostak 2006).
Inflationary expectations lead the suppliers of goods to ask for prices that are above what the holders of money can pay. Potential buyers do not have sufficient money to purchase the goods. The emerging shortage of money, according to Mises, is an indication that the inflationary process has gained pace and cannot be "fixed" by raising the supply of money. Policies that accommodate this shortage can only make things much worse. Ultimately, the sellers demand excessively high prices, transactions with inflated money become impossible, and the monetary system falls apart (Shostak 2006).
All stock market crashes are unforeseen for most people, economists notwithstanding. This is the first lesson of history. Although even economists appear unable to predict the market with any degree of accuracy, or at least to come to a consensus on such predictions, some have learned from their mistakes. Irving Fisher is noteworthy for failing to anticipate the Crash, in fact suffering great losses himself as a result of the crash (Skousen 1995).
"In a few months I expect to see the stock market much higher than today." Those words were pronounced by Irving Fisher, America's distinguished and famous economist, Professor of Economics at Yale University, 14 days before Wall Street crashed on Black Tuesday, October 29, 1929 (Sornette 2002). Afterward, he applied himself to understanding what had happened.
Irving Fisher’s “New Era”
Well after the fact, Irving Fisher identified most precisely and perceptively what he meant by a “New Era.” In trying to identify the cause of the stock market crash and the subsequent depression he found most explanations lacking. What he did find was that new eras occurred when advances in technology allowed for higher productivity, lower costs, more profits, and higher stock prices:
In such a period, the commodity market and the stock market are apt to diverge; commodity prices falling by reason of the lowered cost, and stock prices rising by reason of the increased profits. In a word, this was an exceptional period—really a “New Era” (Fisher 1932, 75).
The key development of the 1920s was that monetary inflation did not show up in price inflation as measured by price indexes. As Fisher noted: “One warning, however, failed to put in an appearance–the commodity price level did not rise.” He suggested that price inflation would have normally kept economic excesses in check, but that price indexes have “theoretical imperfections” (Fisher 1932, 74).
During and after the World War, the wholesale commodity price level responded very precisely to both inflation and deflation. If it did not do so during the inflationary period from 1923–1929, this was partly because trade had grown with the inflation, and partly because technological improvements had reduced costs, so that many producers were able to attain higher profits without charging higher prices (Fisher 1932, 75).
This is the problem of new-era thinking: Technology can drive down costs and increase profits, creating periods of economic euphoria (Thornton 2004). In such a situation, the normal indicators of problems in the market are obscured and producers (and investors) continue their course unchecked, ultimately leading to collapse. Although Fisher was able to analyze this problem, he was still unable to accurately forecast economic health, or lack of it, suggesting "As this book goes to press (September 1932) recovery seems to be in sight." In fact, the Great Depression had hardly begun.
Was the Great Crash predictable or preventable?
While stock market crashes may be inevitable, was the Great Crash of 1929 inevitable in its magnitude? And was a crash of such magnitude truly unpredictable? The failure of the market economy to “right itself” in the wake of the Great Crash is the most pivotal development in modern economic history. Unfortunately, few saw the development of the stock market bubble, its cause, or predicted the bust and the resulting Great Depression. Unless we can learn from this historic mistake, economies may be doomed to repeat such disasters.
Mises showed that attempts by the central bank attempts to keep interest rates low and to maintain the boom only makes the crisis worse (Thornton 2004). He ended his analysis with a prescription for preventing future cycles:
The only way to do away with, or even to alleviate, the periodic return of the trade cycle – with its denouement, the crisis – is to reject the fallacy that prosperity can be produced by using banking procedures to make credit cheap (Mises 1928, 93, 95, 128–129, 143, 147, 171).
A significant issue in the unfolding of the crash was communication. It is said that Henry Ford was taking the elevator to his penthouse one day in 1929, and the operator said, "Mr. Ford, a friend of mine who knows a lot about stocks recommended that I buy shares in X, Y, and Z. You are a person with a lot of money. You should seize this opportunity." Ford thanked him, and as soon as he got into his penthouse, he called his broker, and told him to sell everything. He explained afterwards: "If the elevator operator recommends buying, you should have sold long ago." (Friedberg Mercantile group 1997).
Even at telegraphic speed, the sheer volume of trading was overwhelming. Issues were behind as much as one hour to an hour and a half on the tape. Telephone calls were just busy signals. Crowds gathered outside the New York Stock Exchange trying to obtain information. Police had to be called to control the strangest of riots—the investors of business. Panic prevailed. This all shows the impact of psychological factors, such as emotion, panic in the face of sudden changes that are not well understood, on economic decision making. Without taking into account the "human" factors which go beyond market forces driven merely by the actual supply and demand of goods and money, the economy is vulnerable to dramatic changes such as bank runs and stock market crashes and economists are weak at predicting them.
To see how much things have changed, the events of 2008 can be compared with those of 1929. Like 1929, there were serious problems in the market, with greedy financial institutions (such as Enron, Fannie Mae, and others) using “falsifications” or “enhancing” of basic data. However, in addition to safety measures put in place by stock markets, such as the New York Stock Exchange which now suspends trading temporarily following significant drops in the DJIA, advances in communications technology not only kept trading current but also kept everyone fully informed. With full knowledge of what the current situation is and what the Federal Reserve was going to do, no panic or “run on banks” took place in developed countries. Thus, the danger of completely bringing down the global markets as occurred in September 1929 appears to have become virtually nonexistent.
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