Come the Conflagration

Avi Tiomkin, adviser to international hedge funds, has been highly accurate so far. Now he says: The market as we know it is over.

The world as we knew it is going down in flames. That's the word from Avi Tiomkin, adviser to international hedge funds, who has proved startlingly accurate in his forecasts in the past few years. The policy-makers of the world may be busily trying to calm the troubled waters, but that's their job. But Tiomkin is not responsible for the emotional well-being of the world population.

"A conflagration is igniting," Tiomkin tells TheMarker. "Not only in Israel, but the world wide. This fire is going to consume us all."

Dan Keinan

He is speaking figuratively, of course. "The economic order we've known for the last 60 years, which took shape after World War II, is about to take a bad blow. It's like the Titanic as it began to sink - if the passengers in the lower decks aren't rescued they'll climb up and drag the first-class passengers down with them."

Politicians are supposed to analyze the situation accurately, but they can be excused for sugar-coating their statements. Tiomkin, free of such obligations, is cutting in his analysis and fires in all directions. "To ask someone if he's for the protest is like asking a Japanese if he's for or against the tsunami. I read the statements by Israel's political leaders and what people like [Tel Aviv Mayor] Ron Huldai, or [Central Bottling Company Coca-Cola Israel owner] Muzi Wertheim say, and I realize that neither the political system or the business system understand the protest."

One could dispute the economic analyses offered by Tiomkin, who lives in New York most of the time. But much of their force comes from the accuracy of his recommendations in recent years.

In early 2008, more than six months before the global crisis erupted, Tiomkin recommended buying gold and U.S. Treasury securities. Gold was hovering around $900 an ounce at the time, and the yield on 10-year treasury notes was around 3.9%. By mid-August this year, gold had reached $1,900 an ounce, and as of the end of September the 10-year yield, which is correlated inversely to price, had dived to 1.9%.

For years Tiomkin has steadfastly opined that the euro bloc was headed for an existential crisis.

In April 2008 Forbes ran an article he wrote with the stark headline "The Death of the Euro." The euro was trading at around $1.56 at the time, well before debt crises erupted in Italy, Greece, Spain, Portugal and Ireland. Since then the euro has weakened to less than $1.38.

Since last December Tunisia's government fell, Egypt's was overturned, Yemen's ruler lost his grip and Libyan leader Muammar Gadhafi was deposed and assassinated. President Bashar Assad's regime in Syria is teetering, the euro bloc is under enormous pressure and grassroots protests are washing over the West.

Can you recall a more dramatic period?

Tiomkin pauses before answering. "There is no question that the world is undergoing dramatic change - politically, socially and financially. We're seeing a clear reversal from a world belonging to the private sector and globalization toward a world in which the public sector and governments will make the decisions."

Is this the reason for the losses suffered by top-tier investors such as hedge fund manager John Paulson and PIMCO's Bill Gross?

"Definitely. The ability of private equity and hedge funds to function has sharply declined in the last three years. Banks have collapsed, credit has been harder to come by, many players have been wiped off the map. There has been a sharp increase in regulation. These processes caused a vast decline in trading volumes and liquidity.

"Gross was served well for years by precise analyses of topics such as budget deficits and interest rate changes. But the moment that the system itself changed, these tools became irrelevant. Warren Buffett, too, still operates under the old rules - and he too may live to regret it," says Tiomkin.

For years the global equity markets had been the playing field of institutional investors. It was also the main avenue for exits - selling shares in an investment at a profit - he says.

"Over the last fifteen years the institutional investors were the major players in the financial markets, and they were the creators of the financial models that governed them. This is over."

How do you account for the fact that government bond prices actually rose after the rating agency Standard & Poor's downgraded the U.S. sovereign credit rating?

"The United States is still the basis of the world economy and the global financial system. The U.S. is the only place that still functions relatively well. The error is that one cannot bestow a triple-A rating on the United States. The United States is, by definition, an AAA economy."

Tiomkin sees these processes taking place in Israel too, and again he ties them to S&P. "Instead of taking care of the fire of protest, our finance minister, together with a group of economists who advise him - who of course didn't foresee the economic crisis before it broke out and who didn't understand it when it did erupt and who still don't understand it - are implementing all kinds of old, archaic rules and laws they learned at university. But these rules and laws don't apply any more. We live in a different world.

"The archaism of the finance minister and prime minister are reflected also in their amusing pride at Israel being admitted to the OECD, an organization that also has Greece, Spain and Portugal. Or in Israel's upgrade by S&P - the same agency that gave high ratings to the nations of the crumbling euro bloc, and to subprime mortgages."

Does Israel suffer from economic concentration?

"Israel has concentration and it's a problem, but it's a problem that will go away by itself. Private capital will disappear. Business empires will vanish. It won't be possible to compile lists of the richest people because it won't be possible to know who's really rich and who isn't. The net wealth of many of those on these lists will disappear."

Going the way of Greece

Tiomkin has not taken part in the Occupy Wall Street protest, or any demonstration in Israel either. But he has firm opinions nonetheless. He feels that a lot of supporters had a romantic view of these movements. The Israeli protesters by and large figured that once summer vacation was over and the kids were back in school and the autumn rains began, they could move on. Certainly other Israeli protests didn't last long, including after the Yom Kippur War, the Second Lebanon War, or demonstrations to push for a constitution (Israel doesn't have one: it has Basic Laws ), Tiomkin points out. Tiomkin does not however feel that the protest in Israel was a romantic summer folly.

If so, you probably oppose the recommendations of the Trajtenberg committee, which addressed the protesters' demands from a practical aspect.

"The Trajtenberg recommendations are a joke," answers Tiomkin. "That committee didn't change any priorities. You have to change the underlying terms, or the fire will consume you too. The only way that can be done is by breaching the budget boundaries, almost, I would say, whatever the cost."

What is the recipe, according to Tiomkin? Slash the taxes paid by the bottom 70% of the income spectrum. Slash or abolish VAT on basic items. Reduce gasoline and electricity prices and raise public-sector wages. Build 100,000 rental apartments and slap more taxes on the rich - individuals with assets worth more than NIS 1 million, not including their primary residence, he advises. There is no alternative: Israel either takes these steps or it goes the way of Greece.

"The myth that Israel survived the crisis of 2008 by virtue of its budgetary discipline is wrong," he opines. What saved Israel was that, relative to the country's size, the Bank of Israel's injections of capital into the system were the biggest. Meanwhile, the government dramatically increased spending, which helped both directly and indirectly.

"It is the polar opposite of budgetary discipline," says Tiomkin. "In late 2008 and in 2009 state spending was increased, and what kept the deficit from growing was the dramatic increase in business activity, construction and exports.

"Nor is it true that Israel escaped a real-estate crisis. It didn't escape it; the crisis came later. When the crisis broke out in the world, outstanding mortgage debt in Israel was reasonable and the quality of debt was reasonable. Today we're in a state of crisis, and in my opinion that is one of the reasons Bank of Israel Governor Stanley Fischer is looking for his way out."

How would the budgetary breach you suggest be funded?

"The government would issue bonds to fund it and the Bank of Israel would buy the bonds, such as [Federal Reserve Chairman] Ben Bernanke, Fischer's student, did in the United States."

You sketch a gloomy scenario. Is the conclusion that people should continue to invest in gold?

"Gold will remain the asset that continues to rise under all scenarios. I think it will gain in absolute terms, and at the very least in relative terms. Gold shouldn't be treated as a commodity any more, but as a currency. This does not mean it will not experience high volatility. Hedge funds were big buyers of gold, and the blow they sustained compelled them to sell in order to meet redemptions. That was how they regained liquidity. That's the reason for the current weakness [in gold]. Unhappily, I still see gold as the number-one asset for the coming years. This is the significance of the economic step backward we are experiencing."