As you can read in this manual that very part dates 2002:
At the end of the installation, you will be asked if shadow passwords
should be enabled. Answer yes to this question, so passwords will be
kept in the file `/etc/shadow'. Only the root user and the group
shadow have read access to this file, so no users will be able to grab
a copy of this file in order to run a password cracker against it.
You can switch between shadow passwords and normal passwords at any
time by using `shadowconfig'.
Read more on Shadow passwords in Shadow Password
Furthermore, you are queried during installation whether you want to
use MD5 hashed passwords. This is generally a very good idea since it
allows longer passwords and better encryption. MD5 allows for
passwords longer than 8 characters. This, if used wisely, can make it
more difficult for attackers to brute-force the system's passwords.
Regarding MD5 passwords, this is the default option when installing
the latest `password' package. You can change this anytime after
installation by doing `dpkg-reconfigure -plow passwd'. You can
recognize md5 passwords in the `/etc/shadow' file by their $1$ prefix.
This, as a matter of fact, modifies all files under `/etc/pam.d' by
substituting the password line and include md5 in it:
password required pam_unix.so md5 nullok obscure min=6 max=16
If `max' is not set over 8 the change will not be useful at all. For
more information on this read Section 4.10.1, `User authentication:
Note: the default configuration in Debian, even when activating MD5
passwords, does not modify the previously set `max' value.
This is not the default way passwords are hashed in debian anymore.
In the chapter 18.104.22.168 Password security in PAM you can read that the default option is sha512 from Debian Squeeze (2009).
You have to make sure that the pam_unix.so module uses the "sha512" option to use encrypted passwords. This is the default in Debian Squeeze.
The line with the definition of the pam_unix module will look
password [success=1 default=ignore] pam_unix.so nullok obscure minlen=8 sha512
The problem with these manuals is that there are some parts that are outdated. Community tries to fix these kind of problems if you report them, and you can also volunteer yourself to fix that part of the documentation.