As the financial crisis grew in intensity the big question among economists and investors had to do with the decoupling theory, and specifically whether China would delink from what was going on in the West. The answer of course turned out to be that it wouldn’t; Chinese GDP shrunk to merely 6%, which technically was a contraction because that rate of growth cannot produce the estimated 20 million jobs per month its population requires.

These days, they’re more likely to be pondering the implications that a falling Chinese stock market have for the rest of the world. The Shanghai Composite continued its recent plunge at the start the week because there were more rumors of a planned tightening in bank capital requirements, which naturally will restrict lending and therefore liquidity.

Also hurting stocks there are concerns the government is about to aggressively unwind the fiscal and monetary stimulus measures that have helped re-energize growth. Overall, valuations are about 23% below their peak after a wild 90% surge and the press is all over the idea of a new Chinese bear market.

Things are very different in China than in Western nations in one very important aspect; when the government says lend, banks lend, and the rumors are that much of that government-created excess liquidity had been finding its way into the hands of stock speculators.

When you look closely at things, you’ll see that efforts to reign in what some are calling a bubble probably have more to do with Chinese concerns over where the dollar has been going as global equity markets rebounded this year (down) and relatively little concern about the economy overheating in any way. China has negative inflation while joblessness remains a top concern, which suggests it will be well into 2010 before policy is tightened in a more permanent way.

In the meantime, as seen earlier this year, China is indeed very concerned that the dollar will fall, hurting its huge holdings of U.S. assets as well as weakening its competitive edge on exports. China itself likely helped to weaken the dollar this year as it went on its huge commodity buying spree with its stockpiling of oil, copper and iron ore like there was no tomorrow.

You can always tell when a move in stocks (either way) has legs. The S&P fell 0.81% on Monday as investors dutifully reacted to the Chinese benchmark’s 6.7% plunge. Most concerning was that the fall came on relatively good news; the Institute for Supply Management-Chicago said today its business barometer increased to 50, the highest level since September 2008 and what made the report especially good was that the employment component increased to 38.7 from 35.3.

Another test will come on Tuesday as the ISM reports on it national manufacturing index, which is expected to show growth for the first time in 19 months. If Chinese markets take another dive overnight and the S&P falls on another good number, the correction many have been waiting for might just take hold. September is historically the worst month for equity markets and it may just be that the slight chill in the air could turn investors’ feet a bit cold towards the March rally, at least temporarily.