Google crawls the Web to find publicly declared relationships between people's accounts, just like Google crawls the Web for links between pages. But instead of returning links to HTML documents, the API returns JSON data structures representing the social relationships that were discovered from all the XFN and FOAF.
XF stands for XHTML Friends Network which is a simple way to represent human relationships using hyperlinks by utilizing a simple rel="" property for the hyperlink.
FOAF stands for The Friend of a Friend project and is creating a Web of machine-readable pages describing people, the links between them and the things they create and do.
This is definitely a great approach for Google to take to continue bringing the web together. I see a big problem with their not being enough defined content out there on the Internet for this to be useful quite yet. It appears people like Plaxo are working to solve this with their Plaxo Pulse.
Hopefully this is the beginning of Google integrating more social network relationship controls into their gmail contacts, docs and user controls.