The Attack on Prosperity: How Speculators Are Causing the Cost of Living to Skyrocket

After investing in high-tech stocks and real estate loans for years, legions of speculators have now discovered commodities like oil and gas, wheat and rice. Their billions are pushing prices up to astronomical levels -- with serious consequences for ordinary people's quality of life and the global economy.

Daniel Jaeggi is sitting at a conference table in an office building on Place du Molard in Geneva, only a few steps away from the lake. It is 1:45 p.m. on Friday of last week, and the price of a barrel of the benchmark Brent Crude oil is at $129.50 (€82).

Jaeggi, a 47-year-old Swiss citizen, is a petroleum trader. He and his partner, Marco Dunand, own a company called Mercuria. It is one of the world's 10 largest trading companies. At its offices in Geneva, approximately 110 employees analyze markets, handle contracts and track tanker routes. Last year Mercuria traded in petroleum products worth a total of almost $30 billion (€19 billion). That included millions of barrels of oil destined for China.

"For decades, oil was too cheap. Until 1999, a barrel went for less than $10 (€6.40)," says Jaeggi. Of course, rising economies like China, India, Russia and Brazil have stimulated demand, driving up the price of oil. But what really changed the market were the big pension and investment funds.

Searching for secure and long-term returns, major investors turned their attention to the commodities indexes, investments that promised substantially higher returns than investing in the stock market. The more the funds invested, the higher the prices went, especially since the market for speculative commodities securities is very small. Even minor shifts in the portfolios of large mutual funds can quickly drive up the price of oil.

At 3:15 p.m., the price of a barrel of Brent Crude is at $131 (€83). During the course of the day, traders at Mercuria in Geneva trade up to 4 million barrels of "real" oil and about 10 times as much in so-called swaps -- in other words, oil which only exists on paper -- to hedge against risk.

"The oil price has gone up by about $10 in the last two days," says Jaeggi, adding that in the past it would have taken the market years to achieve the same price increase. Later on Friday, US crude would hit a record price of over $139, up $11 in the largest-ever single day increase.

Last August, the price of oil was $70 (€45) a barrel, in early March it surpassed the $100 (€64) mark, and then the new record high on June 6. What's next?

Ernst Tanner is asking himself the same question, but he is thinking about cocoa, not oil. Tanner is the CEO of Swiss fine chocolate maker Lindt & Sprüngli. He has had to look on as the price of cocoa beans jumped by 40 percent since early 2007, despite abundant supply. "It hardly has anything to do with supply and demand anymore," says Tanner.

The price increases that have affected oil and cocoa apply to almost all other commodities. A sack of rice now costs almost three times as much as it did in January, wheat, corn and soybeans have already reached record prices this year and gold has been on a wild rollercoaster ride recently.

Hardly anyone really needs gold. But oil is the lubricant of our economy. As it keeps getting more expensive, the engine of the economy begins to stall. And wheat and rice, as staple foods, are truly essential to human life. As they become more and more expensive, poor people must go hungry or, in some cases, even starve.

Hundreds of millions of consumers around the world are now wondering what will happen next. For weeks, high food prices have led to unrest in many countries. Demonstrators in Indonesia and Thailand, for example, demanded "more money for workers and farmers." In April, the citizens of Haiti drove their prime minister out of office because of food prices, and the people of Burkina Faso brought their entire country to a standstill for days by staging a general strike. In Somalia, where the situation is particularly extreme, soldiers fired into a crowd of tens of thousands of angry Somalis in an effort to get the situation under control. Rice prices in Somalia had doubled within the space of a few weeks.

The cost of corn meal, a key ingredient in tortillas and thus a staple food in Mexico, has also shot up astronomically. In an effort to ease their plight, Mexican President Felipe Calderón has ordered that the country's 26 million poorest citizens be paid a monthly subsidy of roughly €7 ($11), effective immediately.

Graphic: A Spectacular Rise
DER SPIEGEL

Graphic: A Spectacular Rise

Many European countries, including France, Italy, Great Britain and Spain, have seen protests in recent weeks by those most affected by high gasoline prices. As gas prices consume an ever-increasing slice of their income, farmers, fishermen, taxi and truck drivers are increasingly concerned about being able to make ends meet.

At the same time, the cost of living just keeps going up. Last Friday, Germany's central bank, the Bundesbank, drastically raised its inflation prognosis for the coming year, from 2.3 to 3 percent.

Energy costs are proving to be the biggest burden for ordinary citizens. A worker who commutes between the northern German cities of Hamburg and Lübeck, for example, can expect to pay several hundred euros more for gas this year. The average monthly energy costs for a typical household in Germany have increased by €100 ($157) since 2004.

But this is only the beginning. It is already clear that natural gas will become significantly more expensive during the course of the year, because in Germany the price of gas is tied to the price of oil. Consumers should already be bracing themselves -- and possibly setting money aside -- for hefty increases in heating costs later this year.

The cost of groceries is also on the rise. Pasta is 26 percent more expensive than it was a year ago, while the price of some dairy products has risen by 47 percent.

And what happens when energy prices are fully reflected in airfares? The answer is obvious: More and more Germans will have to think twice about being able to afford their usual vacations.

Many people's standard of living is already at risk, and perhaps the prosperity of the nation as a whole could soon also be threatened.

The question is whether price rises are inevitable, because demand exceeds supply, or whether other, less obvious forces are at work: speculators who are taking advantage of the growing scarcity of resources to make a lot of money fast.

This is about more than just economics. It is also an ethical and highly moral question. Much depends on the answer, including the credibility of our economic system.

Perhaps this is why there are so many voices seeking to defuse the issue and calm things down, those who admit that speculators are at work in the commodities markets, but who also insist that they have little influence over prices. And if they do have an influence, these people say, it can only be a good thing, because it will force humanity to prepare itself more quickly for the unavoidable: the growing scarcity of resources.

"This is not about blame," US Treasury Secretary Hank Paulson recently said. "It's about supply and demand." According to Paulson, "speculators have had very little impact."

But the people who are affected by rising commodity prices see it differently. "The flood of money from Wall Street and hedge funds is driving up prices -- and the effects are potentially destructive," says Tom Buis, president of the US National Farmers Union.

As prices become further removed from reality, another risk begins to grow: the development of another bubble similar to the one fueled by overinflated stock prices in the so-called New Economy. A crash would be unavoidable.

It would be good news for drivers in Germany and the people starving in Africa. But it would also send the financial markets into turmoil once again, causing problems for hedge funds and perhaps a few banks.

Regardless of whether prices go up or down, speculation results in preposterous exaggerations, with real consequences for the economy.

Once again, it is the excesses of modern financial markets that are sending the world economy into convulsions. Indeed, German President Horst Köhler may have been right when he recently said, in an interview with the German magazine Stern, that the financial markets have developed into a "monster" that needs to be tamed.

"The financial industry," says Heinrich Haasis, president of the German Federation of Savings Banks, "has disconnected itself from the real economy."

This is both correct and incorrect.

Graphic: How Futures Work
DER SPIEGEL

Graphic: How Futures Work

It's correct because the transactions concluded in this sector no longer have anything to do with real goods. The industry deals in expectations, and in expectations of expectations, often on borrowed money. And it's also correct because it is an industry in which obscene amounts of money are being earned.

But Haasis's statement is wrong because these transactions can in fact end up affecting the real economy. They can fire it up, as in the years of the recent boom, or they can slow it down, as is the case today. They could also drag it into an abyss, as many still believe is possible in the wake of the most recent credit crisis.

This crisis has shaken the financial markets for months. The central banks were forced to pump hundreds of billions into the global economy to provide it with liquidity and prevent a collapse. The otherwise unpopular state-owned sovereign wealth funds from the Middle East and Asia jumped in, using their money to prop up venerable institutions like Citigroup or Switzerland's UBS.

It is possible that the worst is over, even though it will be a long time before the results become tangible. But it is also possible that other markets, such as the consumer credit market, could be sucked into the same mess soon.

Despite all this, there is still plenty of speculative capital searching for high-yield investments. While subprime mortgage loans may have been all the rage yesterday, today's hot investments include gold and tin, wheat and soybeans. All of this means that the next crisis is already taking shape before the last one has even been weathered -- a bubble following on the heels of a bubble.

They are all back at the table, the hedge funds and the major investors, the ones who will place their bets on anything that promises to yield a profit. But they're not the only ones. American pension funds, such as the fund that manages the retirement pensions for Californian teachers, have also joined the fray. And then there are the countless small investors putting their money into commodities funds, into index funds that simulate commodities prices, or into certificates, that modern investment instrument that even allows the most ordinary of investors to get a tiny piece of the action.

They all speculate that commodities prices will continue to rise, partly because demand is growing while supply is limited. Oil is a case in point. Without it, the world economy would come to a standstill, and Asia's emerging economies are constantly clamoring for more. And then there is food. In China, for example, more people can now afford meat. But it takes three kilograms of feed to produce one kilo of pork. At the same time, many fields are now devoted to growing crops used to produce biofuel.

The trend is clear, and yet it offers only a partial explanation for the steep rise in prices. Living habits don't change that quickly and, as a result, neither does demand. The only thing that changes that quickly is expectations -- which keep on driving up prices.

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