However, looking at the linked pages from the first post, I see this:
"Setup will load as normal, but there is one catch that you need to be aware of here. If you are formatting your hard drive and creating a new partition, you will need to turn off the computer immediately after the partition has been formatted (before Windows starts copying files over). Turn the system back on, boot back into TXT mode then direct Windows to leave the current file system intact. This is done because the flash drive can't copy to the new partition unless the computer is restarted and the flash drive is allowed to recognize the new partition. Strange, yes, but that's just how it works. If you aren't creating a new partition, then just carry on as usual."
From what you describe, it sounds as though the setup is looking at the USB flash drive to try the install instead of the hard drive.
I followed the steps from this how to http://www.ocia.net/articles/xpflashdrive/page1.shtml I have everything added to the flash drive as it shows on the how to. When I try to go to txt mode it says "To set up windows XP now, press enter" I do. It then says "setup has recognized the following mass storage devices in your computers: <none>" I press enter to continue. Then it shows me the partitioned space on the computer. I have one partitioned space, partition1 [fat] and no unpartitioned space. When I press c to create a new partition nothing happens, when I try to delete the partition it says "setup is unable to perform the requested operation on the selected partition. This partition contains temporary setup files that are required to complete the installation." I press enter to continue. It takes be back to the previous screen, now if i press enter to set up windows xp on the selected item it get two options Covert the partition to NTFS and leave the current file system intact <no changes>. If I choose the convert option it says that "Setup has determined that drive U: is corrupted and cannot be repaired. Setup cannot continue. If I choose the no changes option it says the same thing.
Now for a little back ground. This is a gateway netbook lt20 that was running windows XP home edition and this is what i am trying to reinstall. It has no CD drive. Windows is corrupt and needs to be reinstalled. I do not care if I lose anything on the computer i just want it to work again.