OK, well since you asked nicely...and I'm not using a phone browser to respond now...
Disclaimer: I work for Microsoft. I'm not part of the Windows Phone team, I'm not a sales guy, I just happen to be MSFT and so was given an HTC Mozart running Windows Phone 7 back in January. It's my work phone. I also have a Samsung Galaxy S2 as a personal phone.
My Mozart's running Mango but AFAIK the Live contacts sync was also the same for 7.0.
As I say, mine's synced to work Exchange Server, and also to GMail. I have a Windows Live ID, but I use this for sign-in permissions on Xbox Live, various MS sites and nothing else - not for email, not for contacts or calendar. My Live ID uses an email address using my own domain, it's not associated with a Hotmail account or anything else.
What I think is the case is that if you ONLY set it up with a Windows Live account for email (i.e. no Exchange, no Gmail, no POP mail) then it will want to sync all or nothing - mail and calendar and contacts, and you can't disable them individually. If you have an alternate email account setup this isn't the case.
If I go into settings...email and accounts I have Windows Live. In there is a "Content to synchronise" with a checkbox for "email" - nothing else. I presume if I checked this (I haven't) that it may be something happens with contacts.
I also have Outlook (Exchange sync) which has the option of synching email, contacts, calendar, tasks with individual checkboxes for all of them.
Same for Gmail - separate check boxes for email, contacts and calendar.
The use case I'm not sure about (and I haven't got time to test it as, well, it's my work phone) is if you don't use any other email accounts at all and just use Live. If you do this, *perhaps* the phone does not have the concept of "on the phone" contacts and needs to sync them *somewhere*. As I have Exchange and Gmail, when I create a new contact it asks me where I want to put them - in Gmail, or in Exchange or Windows Live. As I've not ticked "sync email" in Windows Live on the phone, it doesn't prompt me to sync them there at all. Not sure what happens if you have a POP mail account set up.
So, in this case I guess you have the option of running an Exchange mailbox (either hosted if acceptable to you or on your own mail server) or an open-source equivalent that you host yourself. There is no longer the option (as in WM6) of syncing your contacts via a USB cable to a local copy of Outlook rather than via an online service of some sort - this is also the case for WebOS, Android (apart from with some cludges) and iOS - strangely...
As I say, this is just my finding, don't speak for my employer etc etc...