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In a week the world economy is looking a lot less sure of itself. The ballooning fiscal deficit in Greece was the trigger. Gerard Lyons, Global Head of Strategy and Economics, Standard Chartered London, speaks on whether this is a containable problem or will the contagion spread?

Below is a verbatim transcript of the interview. Also watch the video.

Q: What do you attribute this sell-off across all asset classes to? Were they anyway getting out of whack with reality or was it the eurozone deficit problem or is the eurozone deficit a game changing problem?

A: I think financial markets had discounted a lot of very good economic news. What we are now seeing is a reassessment of the economic outlook and the realization that growth in the West will be particularly weak and that there are further possible financial problems to come. Moreover, the challenges within the eurozone have very much come to the fore. What we have seen recently both in terms of Dubai before Christmas and Greece recently is evidence that there are not any specific problems but there are wider concerns about problems within Europe or about debt more generally.

Q: How will this deficit problem pan out? How long, how deep will this contagion last?

A: Europe has a deep fundamental problem and that is going to continue to be a big challenge for at least this calendar year. If one takes the UK which is not in the eurozone, it has had a shock absorber in terms of a much weaker pound sterling. However, some of the smaller European countries such as Greece, Ireland, Italy, Portugal, Spain are unable to devalue their currency because they are part of the eurozone. Those countries, particularly Greece, face a period of weak growth, rising unemployment, social tensions to come. In addition to those problems, they now in Greece have to enhance the period of austerity which will compound economic challenges. In a nutshell, the smaller European economies face real challenging economic times.

Q: This problem has resulted in a temporary fleeing of funds to the dollar. Does that make it easier for the US to sell US treasuries and bridge its deficit or will the US treasuries also soon become hit by the same risk aversion?

A: I think people are going to look for safe havens. In recent months, we have seen the safe haven be the dollar itself. That is partly because there are lack of alternatives. I think the dollar faces big challenges later this year when it becomes clear that the US recovery is very weak indeed.

It is equity markets that will start to feel the challenge. US treasuries and indeed bond markets elsewhere will become the safe haven. So, what we have is the realization that in the advanced economies in the West we have a prolonged period of economic weakness and austerity, weak or below-trend growth, rising unemployment, social problems, and political tensions. The debt crisis is the only real way to reduce the big budget deficit as in Greece and America. If we don't have strong economic growth, then the budget deficit problem continues to fester.

Q: How do you see the US economy panning out? Will the confidence one saw in the latter half of 2009 re-emerge or do you see the markets not at all returning to the highs of 2009?

A: A realty check is inevitable in the west particularly in the US. Strong US growth driven primarily by the policy stimulus will continue to post revenue growth in the first half of this year. The reality though is that later this year private sector demand may not take up the slack that point to a prolonged period of low interest rates in the US. The Fed cannot even contemplate increasing rates this year or next year and maybe not even be able to do that the year after that. The Obama administration may have to think about another fiscal boost later this year. The bond market and international investors don't want the bond boost to come in. The reality is that the US economy faces a weak below trend growth. International investors have to remember that after a period of boom which is driven by credit and debt you need a period of austerity.

Q: Where does this weakness in western markets or western economics leave commodities? Do they get cheaper because of weak global growth?

A: The real story here is the shift in the balance of economic and financial power and the new world order even though emerging economies can't boom or outperform if the West is not booming. It really depend on the strength of growth in those emerging economies. We need to see more domestically driven growth in the likes of China, India, Indonesia and elsewhere. Commodity prices will trend a longer-term up and one should expect to see increased volatility particularly in commodity markets through the course of this year.

Q: The dollar index has current risen to 80. Do you see it going to 74 or even lower? How do you see the rupee panning out in 2010?

A: The reality is that currencies don't move in the same direction all of the time. What we have seen recently is that this is a reassessment or risk aversion. The dollar has rallied on that safe heaven flow. As we move through the second-half of this year, one would see a reverse of that and the dollar then underperforming and the rupee and the number of other emerging economies and currencies outperforming. But in the very near-term, risk aversion concerns and worries about the growth picture have given the dollar a bounce which could continue. This would not continue for ever and is not sustainable.