That's even odder. I would not expect that the hide desktop function would be an issue on a remote XP machine. Since it only happens when connecting *from* the Windows 7 PC, you may be correct, though I find that odd.
I'll leave the thread unanswered for now, but please submit a bug report with logs from the remote and local machines of the problem pair per the instructions here.
Please see this post for instructions on how to collect logs and submit a bug on Connect:
http://social.microsoft.com/Forums/en-US/LiveMesh/thread/d52b350a-f3e0-41c6-8e78-d6378e566b9e
Thanks,
-steve
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