When using external storage (flash drives, USB HDDs, digital cameras, MP3 players, ANYTHING except the official MS 20 GB HDD and 64 GB memory card), you CANNOT store game saves or Live content/accounts.
These things require the overpriced, low capacity MS HDD or memory card. It's incredibly annoying and frustrating, but that's just the way it is. There are, of course, people working on this, but no solution so far. Basically, the only thing you can do with your external 40 GB HDD right now is play music, photos, and possibly video (I think I've heard people can do this since the fall update, haven't tried it yet myself, I have no videos in .wmv format). You might also be able to rip CDs to it, again, haven't tried myself.
Oh, just remembered one more thing: There ARE ways to connect the MS 20 GB HDD to a PC, either by cracking open it's case and connecting it to a regular SATA connector, or with certain products you can buy (I don't know any names, sorry) that allow you to connect it to a PC without voiding the warranty on the drive. I *think* this would allow you to backup your saves and Live stuff to a normal PC hard drive (so, I presume you'd actually be able put them on that 40 GB drive you were talking about, if you wanted), so this sounds like it'd be your best bet.
This post has been edited by Tiuk: Dec 28 2006, 12:23 AM