Remember, Apple USED to make 120 & 160 iPods exclusively as a key selling point before the Touches came out, so SOMEBODY must have wanted this!
Tony
No doubt that there are some people who want this. The key is being able to provide it in a way that will make Apple money. The iPod classics have a harddrive in them and this kind of storage is much cheaper than flash storage.
I think that there are 2 possibilities on why Apple hasn't released a 128GB iPod Touch.
1. They would have to raise the price of the 128GB iPod Touch to a point where Apple believes that not many people would buy them.
2. Keep the sale price of the iPod Touch at $399, however, it would so severely cut into the margins that it is not worth it.