Boom or bust? The global economy in 2007

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(CNN) -- In recent weeks, four leading economists and analysts have looked ahead to the prospects for the global economy during 2007.

The fourth and last of these is Dr Gerard Lyons, Chief Economist and Group Head of Global Research at Standard Chartered bank, who has particularly wide experience of the global economy, spending half the year seeing clients in Asia, Africa and the Middle East.

Q. How do you think the global economy will perform in overall terms during 2007?

A. Global growth has peaked and will decelerate in coming years. Such a deceleration should not be a surprise, given the strong performance of the world economy in recent years, growing at its strongest pace in three decades.

Three global themes are likely to dominate: Liquidity; synchronization; and the dollar. Tighter liquidity conditions will slow the world economy. The key will be the US, but if this impacts growth elsewhere then there could be a synchronized downturn.

The last time the US economy suffered a mild recession was 2001, explained then by the US corporate sector having to get its balance sheet back into shape. That it achieved well, and now US firms appear to be in good shape. The key now is that the US consumer needs to get his or her balance sheet back into shape.

If this happens gradually, as we expect, then there will be a soft landing. If it happens dramatically, the downturn could be more severe.

Many international investors see Asia as a high beta region -- outperforming when the world economy is good, underperforming if global growth slows. Yet, in coming years, whatever one's view of the world economy, Asia looks set to outperform, with its economies growing at a faster pace than OECD countries.

Naturally Asia would be impacted by any global slowdown, but structurally, the region looks in good shape. Its high reserves allow the region ample scope to cope with any shock. The emerging middle class and rising intra-regional trade are just examples of structural change impacting the region.

A key issue in 2007 will be China's performance, given its growing regional role. So far in 2006 there are few signs that China is slowing, but policy tightening this summer, plus more to come later this year, should slow the pace of growth in 2007.

If there is too sharp a downturn in the US, the same factors that dampen US growth will hit both export growth from China and investment growth into China. In coming years, it is likely that China will continue to grow at a rapid pace, but there is likely to increased future volatility.

Q. How might oil prices in particular affect economic performance next year?

A. In recent years, high oil prices have not derailed the global economy, as they were accounted for by strong global growth. Thus even countries exposed to high oil prices were cushioned by the benefits from strong global growth and rising trade.

The recent fall in oil prices partially reflects an expectation of a future slowdown, as well as an unwinding of speculative positions. The fact that oil prices have fallen so much recently from their peak will have an important stabilizing influence on some economies, such as the US, and ease inflation worries, both trends set to continue into 2007.

But in addition to this, the fact that oil prices have eased should not divert attention from the fact that, in many respects, prices are still at high levels.

There will be three key consequences of this. First, the Middle East region will continue to benefit, enjoying huge trade surpluses. This will allowing further investment and economic diversification across the region.

Second, countries that continue to see strong domestic demand, such as those in South Asia, may see some feed through from inflation pressures.

Third, the underlying demand for oil will continue to see economies like China and India forge deeper relationships with energy providers across Africa and elsewhere. This latter development is a further reflection of the new trade corridors that are emerging around the world, as flows between Asia, Africa, the Middle East and Latin America continue to grow.

Q. What is the outlook for the US economy?

A. The U.S. is set for a period of weaker, below-trend growth. This will ease inflation worries and help correct, but not solve, global imbalances.

Two of the key drivers behind US consumption have turned from positive to neutral: the housing market and the jobs market, as seen in terms of real take-home pay. Meanwhile, the equity market, another important factor, is still buoyant.

The US consumer needs to spend less and save more. If this adjustment happens gradually, as presently seems likely, the US correction will be gradual. If it is a more dramatic adjustment, the downturn could be hard.

Recent eases in mortgage rates and in gasoline prices, plus the healthy state of the corporate sector, suggests that a soft-landing is more likely. But the big problem is that growth is imbalanced, and when an economy has been so imbalanced, and in turn, so dependent on foreign capital, there is no guarantee that the adjustment will be smooth. Hence the downside risks need to be taken seriously.

Q. What individual factors are likely to be significant during 2007?

A. The key theme will be the growing importance of emerging economies. Increasingly they are playing a more important global role.

The emergence of China and of India are the clearest examples. But the increasing

flows of commodities, of trade, of people, remittances and investment flows between emerging economies reflects their growing might and importance.

Global imbalances leave the dollar vulnerable. But timing is key. International investors are wary of the dollar, but are still attracted by its yield advantage and liquid markets. These advantages may take time to be eroded, but they will.

Asian central banks also play a vital role. A decade ago they held one-third of global currency reserves, now they hold two-thirds, the bulk in dollars. Whilst they are unlikely to sell dollars aggressively, expect further passive diversification, as they place less new reserves into dollars.