As China's stock market completes an eight-day slide, even a muted new margin-lending initiative to deliver a pre-Olympic boost will struggle to turn the tide in the week ahead. Inflation is now the gorilla in the room for investors.

Conventional thinking has said that the subprime crisis was a made-in-America problem and that Asia was the safe haven or even the new institutional "core holding."

As the City in London slashes jobs, new funds in Hong Kong have opened to target markets, consumers and corporates who are debt-light and seemingly far removed from any housing meltdown.

But have the U.S. Federal Reserve's interest rate cuts blown open the decoupling scenario?

It's now becoming increasingly apparent that the Fed's rate-cut medicine has been a particularly toxic tonic for China and many other Asian economies, as they are hammered by the worsening inflationary side-effects.

And it looks as if these less developed economies and less sophisticated corporations are also not as well positioned to manage profits in such an environment.

Last year, China was viewed as the driver behind rising commodities prices. But blame for the renewed surge in soft commodities and oil is increasingly being laid at the door of Fed Chairman Ben Bernanke for taking the fed funds rate to 2% and unleashing a wave of surplus liquidity looking for a new home.

The fallout is now being seen. Countries such as India, China, the Philippines and Indonesia are hiking their own interest rates to rein in rising prices, and others may follow suit.

Vietnam's ridiculous 25% inflation has served as reminder that emerging market risk is still very much alive. With this type of price spiral, the economy struggles to function normally and even the maligned U.S. dollar is starting to rally against the local currency, the dong.

In China, consumer prices increased only 7.7% last month, down from 8.5% in April, but understandably the market is not impressed. With producer prices still rising 8.2% in May, including some hefty increases like coal doubling in price since the beginning of the year, further jumps look to be in the pipeline.

Analysts point to an inevitable fuel price reckoning in China which may exacerbate inflation due to various unsustainable price controls and subsidies. HSBC estimates that if oil prices average $120 a barrel this year, the effective subsidy paid by China to maintain lower domestic prices could reach $27 billion, or 4% of the annual budget.

And without true prices being felt, the incentive to conserve to reduce demand is lost.

Another phenomenon being linked directly back to the Fed policy is how rate cuts led to a surge in hot money flows into China seeking the deposit yield advantage, as well as speculation on the yuan.

Recent reports say China's huge foreign exchange reserves grew by a record $74.5 billion in April, partly fuelled by huge inflows of speculative capital which add to the liquidity in the financial system. While China has capital controls, they do not look to be working. And even if quotas on bank loans are in place, expectations are that money is ending up getting lent in the grey or informal banking system. Notably, China's M2 money supply measure grew 18.1% last month, much faster than expected, and up from 16.9% in April, according to the central bank.

These funds are clearly not flowing into A shares, as the market has now broken below the key 3,000 points level -- down 37% this year.

It's now become apparent that deteriorating fundamentals justify the correction. J. P. Morgan says a mix of rising inflation and slowing export markets has put a squeeze on corporate profitability.

In the first quarter, the external slowdown, rising inflation and raw material costs saw pre-tax profit growth for domestically-listed companies drop to 17.4% on year, from 49.4% in 2007. Companies like insurers whose earnings depend on equity gains face an additional earnings drain.

It could be shaping up for a painful summer for equities until we see signs prices are stabilizing. Any changes in monetary policy or price regulation are likely to be watched closely near term.

Maybe it would help if the world's preeminent central bank joined the inflation fight or considered the global impact next time it moves to prop up an investment bank. For now it seems all equity markets must face the inflation menace together.