I think it's correct to say the loans from the fed isn't going...

I think it's correct to say the loans from the fed isn't going directly into the system.

But it is supposed to. That in fact is their aim - they are trying to get banks to feel confident enough to start lending again. If they don't start lending then the whole thing goes into recession. That's what the bailout bill is all about.

Now the fed is supposed to be able to pull this money back out at a later date. How will it be able to do this? Well, only if things settle down and banks start making money from the loans they subsequently write.

What this means is that the amount of money around probably won't change all that much (if they get it right).

But you can still get inflation - if the amount of capital in the system decreases. If there is less good stuff to pay for with the same amount of money floating around - then you'll see a rise in prices.

The problem I see in the fed's strategy is that they are trying to prevent the bubble from bursting. They are trying to prevent a re-valuation of housing prices downward (as just one example), by preventing the write-offs of debt on the balance sheets. (stop the write off of debt, banks start lending again, people start buying more houses). But this idea is predicated on the belief that enough capital (the sweat off a man's brow) will be created in the future. But I can't see how this could possibly happen.

Joe has already proved that he can't work enough to pay off subprime. He's saying: sorry that promise of capital that I made? Aint gonna happen. But the fed is thinking, nah, in the future, Joe will come good and through his labor produce enough capital to match all the value sitting on the balance sheets. we'll just loan to the banks to see them through in the meantime. Only if Joe does this will you avoid inflation. But has anything changed with respect to Joe? Well if it has, it certainly hasn't been for the better - the american economy is already showing signs of slowing. That means, less jobs - less opportunity to pay off the debt.