Xbox Live's Major Nelson confirmed it on his blog. In a nutshell, on April 6th when the new Xbox system update hits, you will be able to plug in an external drive or flash drive and utilize up to 16GB of extra storage for anything you like. Games, demos, profiles, saves, etc. In fact you can plug in up to two devices at once for a total of 32GB extra storage space. Here is an excerpt from Major Nelson's site.
Since performance on flash based USB storage is usually better, I highly recommend using flash based instead of spinning media like a hard drive…it’s just going to give you a MUCH better experience.
We’ve also enhanced the memory management functions, so you’ll be able to have better control on what you want to copy or move between storage devices.
A couple of points:
You can have 2 devices connected to the console at a time, enabling up to 32GB of simultaneous storage.
The system won’t just configure the device once it is connected to the console. You’ll need to head to the memory area in system settings, select your USB Device, and choose from Configure Now (Format and Configure the Full Device), or Customize (you can choose how much memory you want configured for Xbox360 from the free space on the device.)
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