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.

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.

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.

Commodities: The Biggest Growth Industry of the 21st Century

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.

America's Capital Markets Are Run by 29-Year-Olds

Speculators -- and speculation bubbles -- have always existed, as a look back in history shows. What is new is the sheer volume of speculation, numbering in the billions, in recent years.

This has something to do with modern financial markets and their instruments, known as derivatives, which major American investor Warren Buffet has rightfully described as weapons of mass destruction . But these weapons are only effective because the central banks have created the necessary environment. Never before in history has the world been deluged by such a flood of money.

Since the beginning of the 1980s, interest rates in the world's major economies have trended downwards. The volume of money has grown accordingly, initially at about four percent a year and now at more than 10 percent. When more capital produces less interest income, investors automatically seek higher-yielding investments.

It is relatively easy to follow the trail of this money. Whenever a large amount of capital floods a market, it leaves behind a broad riverbed.

First there was the rally in the Asian Tiger nations in the mid-1990s. Billions of dollars in Western investment helped fuel the booming economies of Thailand, South Korea, Malaysia, the Philippines and Indonesia. But then, in the autumn of 1997, came the crash.

The one party had hardly ended before the next one began. In Moscow, Western speculators gambled with short-term Russian government bonds until Russia became insolvent in 1998. This led to the spectacular collapse of Long-Term Capital Management, a giant hedge fund, which almost dragged the international financial system down with it.

In his book "The Trillion Dollar Meltdown: Easy Money, High Rollers and the Great Credit Crash," American author Charles Morris wrote, "No matter what goes wrong, the Fed will rescue you by creating enough cheap money to buy you out of your troubles." He was describing the policies of the Federal Reserve, America's central bank, and it chairman of many years, Alan Greenspan.

After the dot-com crash and Sept. 11, the Fed lowered the prime rate by five percentage points, thus ensuring that the market would be literally inundated with money. At the time Greenspan, who was worshipped and practically treated as a sorcerer, kept rates at only one percent for 12 months. His successor, Ben Bernanke, took exactly the same approach when the American subprime mortgage crisis struck last year. He has reduced interest rates seven times since last September.

"The liquidity available worldwide is a driving factor in speculation and innovation," says one expert at the European Central Bank (ECB). In addition to the US's aggressive low-interest-rate policy, he cites a considerable expansion of the money supply in Asia. Several teams at the ECB are seeking ways to better understand how the financial markets affect changes in the money supply, thereby indirectly influencing inflation.

Out of fear that the markets could collapse, US central bankers have made money cheaper and cheaper, but in doing so they are fighting fire with gasoline instead of water. As capital grows, it seeks increasingly rigorous new sources of return.

Hedge funds are the most aggressive, collecting vast sums of money and investing them in an extremely speculative manner. If all goes well, they can earn extremely high returns for their investors and, for their managers, salaries that would have seemed inconceivable until not too long ago.

John Paulson is a case in point. A former investment banker, he has managed his own group of hedge funds, largely unnoticed, since 1994. In 2006, he was earning an estimated annual income of $100-150 million (€65-97 million). Though certainly a vast sum by ordinary standards, Paulson's income was relatively modest within the industry, and not enough to merit any media attention.

That changed in 2006 when Paulson, 52, decided to place his bets on a crash in the US real estate market, especially in the subprime sector, while the overwhelming majority of speculators were still betting on unbridled growth. Last year one of Paulson's funds, Credit Opportunities II, climbed in value from $130 million (€84 million) to $3.2 billion (€2.1 billion), a 2,362-percent increase. Paulson himself made it to the top of the industry publication Trader Monthly's ranking of the top 100 earners in the industry -- with an estimated annual income of more than $3 billion (€1.9 billion).

The man in the No. 2 slot on that list, Phil Falcone, recognized potential in Australian iron ore. The senior managing director of Harbinger Capital Partners, Falcone invested heavily in one of the key producers in the industry, Fortescue Metals. The investment paid off, earning him a 114-percent return, and contributing to Harbinger's annual earnings of about $1.5 billion (€967 million).

The new rulers of the financial markets look different than their predecessors, the consistently well-dressed bankers of Wall Street. John Burbank, 44, in his beard, fleece vests and dented old SUV, could easily double as a park ranger. His small company is headquartered in a modest building in San Francisco, as far removed from New York's Wall Street as possible, and yet Burbank is Wall Street's latest boy wonder. Last year his hedge fund, Passport Global Strategy, earned a record 219-percent return.

"You can only achieve these kinds of profits if your opinions are well outside the mainstream," says Burbank. One of his investments was in African coalmines.

Recent data generated by the US market analysis firm Barclay Hedge point to the massive influx of hedge fund money into the commodities futures markets in the past few years. Since 2003, these investments have increased by 372 percent, to the most recent figure of roughly $190 billion (€123 billion).

Sometimes, of course, there is more at stake than investments in coal and iron ore. And in some cases speculators, with their lack of transparency, have bet on an entire economy. The drama currently unfolding in Iceland  is a case in point.

In the past few years, the small country's three largest banks speculated against their own currency because they had borrowed heavily abroad. A few hedge funds got wind of the banks' move and acted on the speculation that the situation would spin out of control.

"Unscrupulous dealers" from abroad were trying to drive Iceland's financial system to collapse, said David Oddsson, the head of the country's central bank. He raised interest rates to a record high of 15.5 percent in an effort to save the Icelandic currency, the krone. Since the beginning of 2008, the krone has lost 20 percent of its value against the euro, partly as a result of the actions of the Icelandic banks.

The investors have another trick up their sleeve, though. Now they are speculating that the Icelandic banks will go under. But the Icelanders are fighting back. To raise fresh cash one of the institutions, Kaupthing Bank, is attracting German investors with a record 5.65-percent interest rate on money market accounts.

Meanwhile, the central banks are preparing for the worst. The Scandinavian countries have pledged to provide Iceland with up to €4.3 billion ($6.7 billion) in emergency cash if its central bank ends up having to bail out the banks. The ECB has also been made aware of the problem. It looks as though it is time for the hedge funds to admit defeat, at least for now, in their battle for the island nation.

It is not unusual for hedge funds to speculate and lose, and many have already failed as a result. Although there has been no major meltdown yet, the possibility cannot be ruled out. It will happen if several of these funds bet on the same horse, lose and then drag their lenders down with them. This is because hedge funds operate primarily with borrowed money, which makes them both highly promising and risky at the same time.

Of course, speculation is not a business reserved exclusively for these major financial jugglers. Millions of small investors are part of the game, consciously or not. Commodities speculation secures their retirement pensions (unless something goes wrong), and it is part of the diversification strategy of their life insurance companies and investment plans. Small investors are now also able to invest directly in oil and grain futures.

"A lot of money can be made in this business if you properly utilize growing worldwide demand," Charles Valdes said enthusiastically less than two years ago. He is in charge of investments for America's largest pension fund, the California Public Employees' Retirement System (Calpers).

Valdes has already invested more than $1.1 billion (€710 million), compared with $450 million (€290 million) in the commodities markets on behalf of the pensions of 2.5 million California public employees. The money is intended to "diversify our portfolio and reduce our risk," says Valdes.

Powerful investment fund companies are also jumping on the bandwagon. In the last 12 months, they introduced 52 index funds specializing in commodities in the United States alone. These instruments mirror the industry indices issued by Standard & Poor's and Goldman Sachs, in the expectation that prices will continue to rise.

Germany's booming certificate industry operates in a very similar way. With more than 300,000 securities being traded daily on the world's exchanges, any ordinary investor can bet on changes in the price of Super Unleaded gasoline, zinc or soybean meal. The price of these debentures issued by banks also follows the fever charts of international quotations, such as those on the Chicago Board of Trade and the London Metal Exchange. German private investors have already bought shares worth more than €130 billion ($202 billion). The banks are hedging their investments by buying the corresponding futures, thereby driving up prices.

Because the stock markets are no longer as attractive an investment as they once were, many banks are also betting on commodities. Ethical qualms are generally not mentioned in their promotional literature, nor do they note that private investors pay for their investments elsewhere, at the supermarket or when filling up their gas tanks, for example. And hardly a banker is likely to point out that lucrative fund prices translate into rising food prices in places like Burkina Faso.

Be a part of the rally in oil prices but at little risk, the US bank JP Morgan tells its customers. Merrill Lynch even offers an investment product called the "Emerging Markets Fertilizer Basket."

Speculators pricked up their ears a few weeks ago, when leading agricultural experts warned officials at the United Nations Educational, Scientific and Cultural Organization (UNESCO) that they could expect to see more and more people going hungry in the future. Rice, once a niche product on commodities futures exchanges that attracted little notice, had caught their attention. Before long, figures were being circulated and the speculators realized that rice is the main staple food for more than half of mankind, especially in Asia and West Africa.

The Dutch bank ABN Amro was the quickest to react, issuing a certificate that made it "possible, for the first time, to participate in the top food product in Asia." Now that India has imposed a ban on rice exports, "worldwide reserves will decline to minimum levels," writes the bank, implying that rice is a hot investment opportunity.

The certificate has been so successful among small investors that other banks are now considering issuing rice certificates, as well. However, the rice price has since dropped significantly again. Ironically DWS, German bank Deutsche Bank's fund subsidiary, advertised a new global agricultural fund on the bags German bakeries use to wrap bread and other products.

The commodities issue comes just at the right time for the certificates industry, providing it with a new and effective tool to attract customers. Until June 29, investors in Germany will not be liable to pay taxes on profits from speculative investments. Those who invest after the cutoff date, though, will have to pay a 25-percent speculation tax on capital gains, which, before the new rules come into effect, are tax-free if held for at least a year.

The mood is heated and opportunities abound, bringing back memories of the best of times in the New Economy (shortly before the worst of times began). Some analysts at investment banks have acquired cult status once again -- just like Henry Blodget and Mary Meeker, analysts at Merrill Lynch and Morgan Stanley, respectively, who fueled the dot-com boom for years with their optimistic prognoses.

Arjun Murti at Goldman Sachs plays a similar role today. The oil analyst is famous in his industry. His bold predictions have almost always been correct, at least until now -- to the point that his latest reports always trigger minor shock waves in the markets. In the spring of 2005, he predicted that the oil price -- at about $50 (€32) at the time -- would approach $105 (€68) by 2009.

On May 6, Murti said that a price of up to $200 (€129) a barrel was "increasingly likely" within the next 24 months. Prices promptly shot up. "The Goldman report gives fund managers an excuse to push prices up even further," says Michael Fitzpatrick of MF Global, the world's leading brokerage house for futures transactions.

Financial programs on television have also clicked into high gear. Business channels, like CNBC and Bloomberg in the United States, are doing their best to fire up the mood. Where past reports focused on the latest numbers of hits on Amazon's and Netscape's websites, tickers now scroll across the screen, showing the current prices of gold, silver, gas and oil. Talk show hosts, investors and analysts are constantly embroiled in heated discussions of "America's oil crisis" and the "housing bubble." Of course, part of their discussions revolve around the best ways to turn a profit from these calamities.

Jim Cramer is the new mini-speculators' shrillest media personality. The former hedge fund manager has remade himself into an entertainer of sorts for American financial television. On his chaotic show, "Mad Money," he occasionally throws chairs through the bright red studio. He is constantly pressing various red buttons to trigger sound effects -- a Hallelujah chorus, machine gun fire or the sounds of bulls, bears or pigs -- to correspond to his shouted investment tips. Wind turbines are in short supply: drum roll! The container shipping industry is about to experience a major comeback: applause! The oil boom could see an occasional mini-crash: machine gun fire!

There is hardly a better backdrop for the rampant global capitalism of speculators large and small. No wonder even the occasional insider is starting to feel queasy, while more and more people are wondering how the out-of-control markets can be subdued once again.

A lack of regulation has allowed the financial industry "to become far too profitable and much too big," says George Soros. The legendary investment guru has been warning for years of the dangers of the global money business. In a hearing before the US Congress last week, Soros even spoke of a "super-bubble" that he believes has been building over the last 25 years.

The record high oil prices are also the result of a bubble, according to Soros. "Speculators and index funds that follow the trend are only increasing the pressure on prices," he says. For this reason, Soros proposes making it more difficult for pension funds and index funds to trade in futures contracts on the commodities markets. One method would be to impose higher minimum investment requirements for speculative capital.

Kenneth Griffin is also one of the major players in the market. His hedge fund, the Citadel Investment Group, is worth $20 billion (€13 billion) and is one of the most successful in the industry. Nevertheless, he sometimes gets a queasy feeling when he thinks about the business. "Walk across any of the trading floors -- they are full of 29-year-old kids," Griffin recently complained to the New York Times. “The capital markets of America are controlled by a bunch of right-out-of-business-school young guys who haven’t really seen that much. You have a real lack of wisdom.” According to Griffin, bank executives now understand only "part of their business." He believes that the industry needs better regulation.

"We must create a financial system in which there are no perverse incentives, the risks are properly recognized and managed, and there is less borrowing," says Mario Draghi, the head of Banca d'Italia and president of the Financial Stability Forum, a group founded by the seven leading industrialized countries 10 years ago, in the wake of the Asian financial crisis. In April, Draghi presented a 70-page document detailing proposed measures to strengthen the stability of markets.

For instance, Draghi writes, banks should be urged to use far more of their own capital to invest in complex financial products. Hedge funds and other major speculators, he adds, should be forced to finally disclose their activities and risks.

"The proposals are efficient, but they also have to be implemented at some point," says Hans Tietmeyer, the former president of Germany's central bank, the Bundesbank, and a co-founder of the forum. According to Tietmeyer, Americans and Britons are constantly demanding exceptions for their companies the minute acute crises are over.

In addition to tighter regulations, economists are also calling for stricter monetary policy. This means higher interest rates, less inflation and, ultimately, a stronger dollar. "Investors worldwide see commodities as a hedge against inflation," says Ben Steil of the American Council on Foreign Relations. This means that as long as the dollar remains weak, oil prices will not decline. For starters, oil is the world's new reserve currency.

Meanwhile, in the offices of hedge funds, pension funds and investment firms, a feverish search for the next big thing is already underway. Conservative investments -- concrete things that cannot go up in smoke as easily as a futures contract on the Chicago and New York exchanges -- are suddenly back in vogue.

In keeping with the new trend, hedge funds and investment banks have started buying up farms worldwide. Morgan Stanley, for example, already owns several thousands of hectares of agricultural land in Ukraine. An agriculture fund operated by Blackrock, a New York investment group, acquired more than 1,100 hectares (2,717 acres) in Britain's Norfolk County. Others are combing the world, from Russia to South America, for investment opportunities. In Argentina, prices for the most productive fields have increased by 80 percent in recent years.

The British hedge fund Emergent Asset Management is currently collecting €1 billion ($1.55 billion) to buy up African farmland south of the Sahara Desert.

"Hedge fund managers may not be good farmers," says Paul Christie, Emergent's marketing chief, "but with the right partners they can be good farm managers."

MARKUS DETTMER, FRANK HORNIG, ARMIN MAHLER, CHRISTOPH PAULY, WOLFGANG REUTER, JANKO TIETZ

Translated from the German by Christopher Sultan