The nosedive reveals just how addicted markets have become to the flow of central bank stimulus and the faith that cheap money remains the path to economic deliverance. The problem: Both are at risk.

A recent working paper by the vice president of the St. Louis Federal Reserve Bank finds that after six years of quantitative easing that swelled the Fed's balance sheet to $4.5 trillion, "casual evidence suggests that QE has been ineffective in increasing inflation" and only seems to have boosted stock prices.

Complaints once in the realm of conspiracy theorists wearing tin foil hats are now being embraced by the Wall Street establishment. In a note to clients, Deutsche Bank analysts warned that "the fragility of this artificially manipulated financial system was exposed" and that "the only thing preventing another financial crisis has been extraordinary central bank liquidity and general interventions from the global authorities."

They argue that "the genesis of this recent sell-off has been the threat of the Fed raising rates next month, but China's confrontational move two weeks ago and the subsequent knock-on through [emerging markets] have accelerated us towards something more serious."

Over at Barclays Capital, economists Michael Gapen and Rob Martin pushed back their rate hike forecast to March 2016. They admit Fed policymakers are "market dependent" and won't tighten policy in the maw of a stock correction, even as they see "economic activity in the U.S. as solid and justifying modest rate hikes." Should the market turmoil continue, the rate hike could be pushed past March.

Alberto Gallo, head of credit research at RBS, is more direct:

"Policymakers responded to the financial crisis with easy monetary policy and low interest rates. The critics — including us — argued against 'solving a debt crisis with more debt.' Put differently, we said that QE was necessary, but not sufficient for a recovery. We are now coming to the moment of reckoning: central bankers look naked, and markets have nothing else to believe in."



Gallo believes an overreliance on excess liquidity has actually hindered capital investment — as companies have focused on debt-funded share buybacks and dividend hikes instead — limiting the global economy's potential growth rate.

Now, contagion from China — lower commodity prices, lower demand, currency volatility — has revealed the structural vulnerabilities. More stimulus, in his words, "could be self-defeating without fiscal and reform support."

As for Fed hike timing, Gallo sees the odds of a September liftoff at just 30 percent, down from 36 percent last week, based on futures market pricing. December odds are at 60 percent.

The open question is: Should the Fed delay its rate hike and the People's Bank of China ease, will stocks actually rebound? Or has the Pavlovian reaction function been broken by a loss of confidence? We're about to find out.