> Xlib: connection to "mylocalIPaddr:0.0" refused by server
> [snip]
> xterm Xt error: Can't open display: mylocalIPaddr:0.0"xterm &".

You have to tell the X server to allow connections from the remote
system. See man page for xhost. Xhost must be run from the machine
running the X server (your desktop system). 

> if i modify $DISPLAY to "localhost:0.0", then "xterm Xt 
> error: Can't open
> display: localhost:0.0" appears when i issue xterm&

This will only work if the client is running on the same system as the X
server and 'xhost +localhost' has been run. Since your Linux on Z guest
does not run a X server (if it is, why are you wasting all those cycles
when you don't have a display to manage?) this will always fail. 

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