US Needs Austerity Too: Hedge Fund Strategist

The United States will have to adopt austerity measures similar to the ones taken in Europe, because the problems faced are largely the same, Timothy Scala, macro-strategist at Sophis Investments, told

On Monday, German Chancellor Angela Merkel presented plans to save 80 billion euros ($95.2 billion) by 2014 by cutting handouts to parents, axing 15,000 government jobs and delaying some construction projects financed by the government.


European Union Economy Commissioner Olli Rehn warned on Tuesday that euro zone countries may need to prepare more budget cuts, without specifying which ones.

And on Wednesday, German Chancellor Angela Merkel and French President Nicolas Sarkozy urged the EU to consider a wide ban on short selling of shares and state bonds, as speculation has intensified that some European states will eventually default on their debt.

In the US, a Treasury Department report sent to Congress shows that public debt will rise to 102 percent of gross domestic product by 2015 from 93 percent this year, to $19.6 trillion.

"We can't kick this can along the road forever," Scala said about the US debt problem. "If we continue to stimulate by issuing more debt or by printing, it's going to make it worse."

"This debt balloon has arrived. You will ultimately see it in the US," he said in a telephone interview.

Europeans have opted for austerity while US Treasury Secretary Timothy Geithner is still on the side of stimulating growth, and some analysts are saying that now is not the time to crush the recovery with austerity measures.

"At a time like this, it's way too early in this recovery especially for Europe and especially for the UK to be talking that game," Hugh Johnson, an investment strategist at Johnson Illington Advisors, told CNBC.

"It's too soon to reduce (stimulus) or to eliminate it. I agree at some point you have to do something, but it's way too early," Johnson insisted.

Scala argued that the stimulus has increased the size of the public sector and that structurally the US has "huge problems", just like the euro zone.

"I don't think the government stimulus can create wealth," he said. "The public sector job growth has been enormous. The government has rapidly become the employer of last resort."

Raising taxes, such as capital gains and income taxes, would add revenue to the budget, but the boost would be short-lived because this would affect the private sector, according to Scala.

"We have bad choices and worse choices, because we've spent way too much," he said.

Inflation Down the Road

An overhaul of public spending in the US is needed, as spending on the health-care program is too high, according to Scala.

President Barack Obama's health-care reform law was passed by Democrats in Congress after a protracted political fight but around 20 US states are trying to overturn the reform in court, saying it will force massive new spending.

Lawmakers could choose not to fund the program and it "will wither and die," Scala said.

Apart from this, the US should reduce taxes on capital gains to stimulate investment and create tax incentives for the use of natural gas, to improve the country's trade position, he said.

Scala added that another reform needed to boost the economy would be bringing back accelerated depreciation on commercial property, which is experiencing its worst liquidity challenge in almost 20 years, according to the National Association of Realtors.

"Right now, if you were to do that, you'd incite a lot of investors in the commercial market," he said.

Austerity is needed to cut the debt burden because the risk is that it will be financed by more debt or by printing money, which would in turn cause inflation as investors will take refuge in commodities, Scala explained.

"I'm afraid we'll see inflation like in the 70s, at some point," he said.

For the moment, inflation is under control because unemployment is high and commodities are sold to pay off debt, according to Scala.

He said that the euro is likely to keep falling and reach $1.05 if problems in Europe continue.

"Civil unrest is the risk. I do see unions and strikes and a very nasty summer, as people are being told they are going to lose their entitlements," Scala said.

His hedge fund is selling the euro on rallies and "will continue to do so until things change," he added.