Google's new version of its Desktop toolbar will copy the files on your computer to its servers, where you can search them. Ostensibly, this free service is designed to make life easier for people that have multiple computers (like a desktop machine and a laptop). By letting Google index all the files on both computers, you can find any file on either machine simply by searching Google.
Google promises it won't really peek at the files (although they must be read to be indexed), and that it will delete the files after thirty days if you are not using the service. And I've got swamp land in Florida I'd like to sell you.
Google may promise it will keep your files private, but I bet it is not keeping the indexes generated by the files private. It will use the indexes to better target advertising to you. So if you like fly fishing and have numerous files on your computer about fishing, Google will notice your index has many references to fishing and you will start seeing more ads about fishing tackle popping up.
Without careful configuration, the software will happily grab your income tax records, your business and accounting files, your love letters, and just about anything else on your computer.
Once Google has them, it becomes much easier for law enforcement or a civil suit to subpoena the records if someone decides they want to know more about you. A disgruntled employee or an angry neighbor could wreak havoc with your private life.
I would not touch this service, period. It's just too risky. And there are plenty of programs that will index all the files on your computer already--and they don't require turning over all your entire electronic data files to a third party.