In SharePoint Server 2007, when you set an alert, you can add  the email
account but it must be one that resolves to a user.

That is, when I went to actions, set alert  on a document library, there
was a box for me to add a user or an email  but the picker had to resolve
it to a user account or it would not accept it.

That's correct and by design. The email  address must resolve to a user
with permissions in the site, since alerts  are security trimmed.

That's what I tried to say, but evidently it did not come across.