No one knows how expensive oil would be if there were no speculation, but it would certainly be cheaper. And if it were cheaper, we would all be paying less for gasoline, heating fuel and hot water. The Germans, and everyone else, would have more left over to cover the cost of living and to consume products, and more and more billions would not be removed from the German economic cycle.
If oil were cheaper there would be less inflation, and the European Central Bank (ECB) would not be forced to keep interest rates as high as they are today. It could reduce rates instead of, as ECB President Jean-Claude Trichet announced last week, raising them in the near future. Lower interest rates would stimulate the economy and bring the soaring euro back down to earth, which in turn would benefit the economy and have a positive impact on the labor market.
Instead the recovery is in jeopardy, as are many jobs. Inflation, in addition to making goods more expensive, also redistributes wealth because it harms the poor more than the rich.
But because no one knows how much cheaper oil would be if there were less speculation, no one knows how significant the impact of speculation is. That it exists is clear, as is the fact that it affects everyone -- every citizen and every business.
But all of this is relatively harmless compared with the speculation over food products. Instead of affecting only the cost of living, speculation in food commodities can be a matter of life and death. When food prices rise, the poor can no longer afford food and are forced to go hungry.
For this reason, there is also a side to speculation that many, especially those who stand to make a quick profit, choose to ignore. In doing so, they also ignore the results of their actions.
Globalization, a success story for many until now, has stalled. After initially helping hundreds of millions of people escape from poverty, it is now showing its ugly side. As profits grow on one side of the world, hunger is on the rise once again on the other.
It's a completely different story on the computer screens of Wall Street analysts, where commodities are the biggest growth industry of the 21st century. Vast sums of money are being invested in the markets for food commodities and energy. These markets, which have been relatively straightforward until now and have operated in accordance with the same principles for decades, are suddenly being overrun by financial investors.
In late 2003, they invested only $13 billion (€8.4 billion) in the food commodities business. By March 2008, that number had jumped to $260 billion (€168 billion), an increase of 1,900 percent.
Last year, new investments in the commodities markets amounted to roughly $100 million (€65 million) a day. At the beginning of this year, what had been a steady flow turned into a torrent, with more than $1 billion (€650 million) flooding the market every day. Hedge funds, banks, pension funds, investment funds -- in other words, groups that represent millions of small investors -- are all involved. At first they invested their money in the dot-com market, then in real estate, and now agriculture and the energy markets are the hot new investment opportunity.
From the point of view of fundamental investment analysis, there are good reasons to continue to bet on further increases in commodities prices. Resources are becoming scarcer, while global demand for energy, mineral resources like copper and coal and crops like wheat and corn will continue to rise. Traders on the commodities exchanges call it a "supercycle" -- a trend that will continue for a long time.
The problem is that commodities don't behave like stocks or mortgages, the last two darlings of the investment community. It is often the case that many fund managers cannot (or choose not to) understand the specific rules of their latest toy on more than a superficial level. They trade in pieces of information that mean nothing until they are in possession of one of them.
Sometimes all it takes is a heavy rainstorm in Iowa to trigger a rally on the corn market. A poor harvest could reduce supply. Less supply drives up prices -- and higher returns for commodities traders.
In the case of oil, a foggy day in Houston's harbor is enough to trigger a panic in the market because it means that a few tankers will be unable to unload their cargos until the fog lifts. When a pipeline burst in Canada, "the price immediately jumped by $4," says Fadel Gheit, an oil analyst with Oppenheimer in New York with 20 years of experience in the industry. Gheit, also an engineer, knows how pipelines are repaired. "This isn't heart surgery. It's a plumber's job, child's play, finished in three days," he says. "The traders use every excuse in the book to drive up prices."
As a young man, Gheit was still analyzing oil prices at $4 a barrel. The ritualized relationship between production volume and consumption, demand that has been growing for years in China, unrest in the Middle East or Nigeria, the threat of cold snaps -- none of this is enough to explain the current price explosion, says Gheit. In fact, he is convinced that speculators are completely responsible. "It's pure hysteria," he says.
Other analysts agree. "The market is reacting to the fact that we might not have enough oil in the market 13 years from now -- excuse me?," says Edward Morse, chief energy economist at the investment bank Lehman Brothers. "You never recognize it's a bubble until the bubble is over." he says.
Signs of unusual behavior abound across the commodities markets. Take cotton, for example. In late February, the price of cotton futures jumped by 50 percent within two weeks. But cotton farmers haven't even been able to sell half of their harvest from the previous year yet. Warehouses in the United States are fuller than they have been since 1966. Indeed, all signs point to a price decline.
In a statement to the US Congress, the American Cotton Shippers' Association blames this "irrational" development on "speculators driving up prices." According to the trade group, cotton processors would never pay the fantasy prices being quoted on the commodities futures exchanges.
Two worlds have developed. One is the world of the traders at hedge funds and investment companies, and the other is that of farmers, grain dealers and mine operators. They may be dealing in the same commodities -- barrels of oil or bales of cotton, for example -- but for some these are nothing but abstract concepts while others see them as down-to-earth products.
The problems arise when these two worlds intersect, the fantasy world of speculators and the real economies of cotton processors and coffee roasters. It leads to distortions, like those currently affecting the cotton market.
Speculation is not necessarily a bad thing. When a market sees billions in new investment, it can stimulate trade, which benefits everyone, improves efficiency and brings about a surge of modernization.
But for some time now, the massive gambles being taken by new financial investors have allowed the commodities futures exchanges, especially in Chicago and New York, to function like a perfect casino. Traditionally the exchanges enable farmers and grain wholesalers to sell harvests early using so-called futures. In a futures contract, the volume, price and delivery date of a given commodity are stipulated in advance, even when the grain is still billowing in the wind on farmers' fields.
For farmers and their customers, futures contracts are a way of hedging against adverse weather conditions. In the case of metals and energy, futures help market players offset excessive price fluctuations and control the delivery of their product.
It is precisely this mechanism that speculators use to their benefit. They buy contracts for the delivery of commodities like wheat or oil when prices are low, thereby betting the billions they invest on prices going up. Traditional commodities traders stand little chance of successfully resisting such speculation. Speculators, by virtue of sheer volume alone, now control the markets. In Chicago, the home of the world's largest commodities futures exchange, the volume of grain futures being traded is already 30 times as high as annual grain production in the United States. This trend is unlikely to be curtailed anytime soon. This year, brokers in Chicago have already entered into 20 percent more contracts than in the same period last year.
Prices for wheat, rice or pork have always been negotiated among farmers, dealers and their customers. The same thing normally holds true on the commodities exchanges. In the end, futures transactions eventually lead to the actual delivery of a product. In industry parlance, this is called real trading.
But those days are gone. Real trading, says Hubert Gabrisch of the Institute for Economic Research in the eastern German city of Halle, has "become the exception on the exchanges." In the case of wheat, for example, only three percent of traded volume actually changes hands. Prices are now determined by speculators, financial jugglers with no interest whatsoever in having any contact with or physically delivering the vast amounts of grain they own.
A bushel of wheat, a biblical quantity, has become an abstract number in the offices of New York hedge funds, a number perfectly suited for gambling purposes. In most cases, that number has very little to do with the actual value of the staple food behind it.
Speculation is mentioned for the first time in the Old Testament. The ruler of Egypt, who had dreamed that seven abundant harvests would be followed by seven poor harvests, encouraged the practice. To avert this disaster, he created what might be seen as the first government fund in world history, with which he stockpiled grain on a large scale, thereby driving up prices.
A classic archetype for all future panics is the Dutch tulip mania of the 17th century. In 1636, at the height of the bubble, the most highly coveted bulbs, such as the Viceroy and Admiral van der Eyck species, commanded prices on par with the cost of an entire house. All social classes succumbed to the hysteria. Contemporary paintings depict butchers, guards, shipping agents, students and chimney sweeps trading the bulbs in taverns.
But then the Dutch public's faith in a permanently golden future for the tulip collapsed. At a tulip auction in the city of Haarlem on Feb. 4, 1637, not a single finger was raised when the first bulb went under the hammer. The auctioneer dropped the price, but still no one moved. This led to a widespread selloff of bulbs, causing prices to plummet.
The country plunged into a deep depression. As is so often the case after overheated speculation, the government had to step in and banned the use of futures contracts, which was already customary at the time. Preachers castigated the speculators from their pulpits, calling the affair "God's punishment for the blasphemous greed and stupidity of the masses."
Failed speculation, followed by hardship and suffering, has been around since human beings first engaged in commerce. And it has always been the fatal combination of excessive liquidity and the herd instinct of speculators that has caused markets to climb and then explode and ultimately collapse.
It seems that every generation has its own speculation to cope with, must experience for itself how unlimited optimism can turn into despair and surefire investment opportunities into laughing stocks practically overnight. Speculative bubbles of the past have included the run on the South Sea Company in 1720, the British railroad bubble in 1846, the stock rally leading up to the 1929 world economic crisis and the dot-com bubble of the late 1990s. The sheer folly of a bubble never becomes apparent until after it has burst.
The boldest speculators are either ridiculed or admired, depending on how well they have done. In 1992, George Soros's successful decision to gamble billions against the British pound launched his reputation as an ice-cold gambler. Others ended up in prison, like Nick Leeson, a young British stock trader who gambled away more than £800 million in the mid-1990s. When he could no longer hide his losses, he left behind a short note at his desk ("I'm sorry") and fled. His actions led to the collapse of his employer, Barings, England's oldest investment bank.
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