What this means is, that the ongoing inflationary trend is not "real". It could suddenly reverse itself into a very aggressive deflation. If the cycle of credit is broken, the credit-based part of the money supply could contract very suddenly.

A large amount of defaults can propagate upwards in the chain of lending, decimating the bank accounts of each link without actually reducing a single dollar from the monetary base. We could be witnessing the first steps in such a collapse right now. First it's the home owners, then the hedge funds that own Mortgage Based Securities, then the banks that provide the leverage to those hedge funds.

One can think of it this way: The total amount of US currency in circulation is about the same as the current account deficit (ca. $800 bn). If foreigners stop lending their dollars back to the US economy and start to hold them as cash, they could very soon cause an actual shortage of cash in the US. Holding dollars in cash would suddenly be a very tempting idea, if a massive deflationary trend would show up. This could be started by the ongoing housing deflation. A deflation expectation would make people even more prone to holding cash, and the cycle would rapidly accelerate out of control.

If the FED responds to this by rapidly printing more cash, an even greater inflationary wave of liquidity would follow when the credit starts to expand again.

The markets are also full of derivatives that are supposed to handle all risks. What happens if major sellers of credit derivatives start to default on their obligations? Does anybody control the amount of risk that these companies can buy? What happens, when investors have sold their credit risks to a company that has bought more than it can deliver?

The current proportion of credit to currencies worldwide is very high. This means, that the money supply is not stable. All central banks should start to work towards a steady correction to the excess amounts of credit worldwide, perhaps by steadily increasing the reserve requirement ratios. If credit is allowed to grow without limits, it could suddenly explode by itself, bring ing the whole worldwide banking industry to a collapse.