What's that you say? Read the manual?
When Google Desktop Search is integrated with Google web search, what you're really doing is sending your query to two different programs and places. One copy of your query goes to www.google.com, which searches only the web and returns a page with those results to your computer. Another copy of your query goes to the Google Desktop Search application running on your computer, which searches only its cache on your computer for results. Google Desktop Search also intercepts www.google.com's results page before you can see it, changes it to include the Google Desktop Search results, and then lets your web browser show it to you. Google never knows what your Google Desktop Search results are."
So it appears it's both very cool software and well implemented so as to avoid the insecurity of sending personal data over the wire.