If you convert 720x480 to 480x320 then you'll either end up with a squished screen (everything will look tall and thin) or the sides will be cut off, depending on your conversion settings, because you're either compressing or cropping a 16:9 widescreen video to a 4:3 aspect.
This is just not true.
First, for a few standard aspect ratios ...
16x9 video is 1.777...:1
16x10 video is 1.6:1
4x3 video is 1.333...:1
Now ... when you scale that to common resolutions what do you find?
Older widescreen movies are traditionally 1.85:1, which is actually slightly wider than 16x9. Modern HD resolutions (720p and 1080p) are true 16:9.
Now ... what about standard DVD resolution? It's 720x480, so you got that part right. The ratio, however, is a paltry 1.5:1. That's pretty close to 4x3, isn't it?
The iPod touch screen, in video orientation, is 480x320. That scales, exactly, to 1.5:1 ... exactly the same as DV or DVD resolution. Interesting, eh?
The problem is that very few movies, if any, use the native resolution of a DVD. That's why, even on widescreen TVs, you'll get bars on the top and bottom for most movies. Look at the Matrix movies (2.35:1, IIRC) and you'll understand the problem.
The iPod's screen is perfectly proportioned to standard DVD resolution and, for the sake of arguement, is a pretty good compromise between "true" widescreen (16x9) and "true" full screen (4x3) ratios.