Either iPad 2 will have a standard 1024x768 display or a doubled 2048x1538 Retina Display, or developers and users will be in for the type of frustration usually ascribed to Android. That's because, if Apple leaves iPad 2 at 1024x768, existing iPad apps will look just fine. If Apple pixel-doubles iPad 2 to a 2048×1536, existing apps will just use 4 new pixels for each 1 old pixel but remain the same physical size and still look just fine. Anything else and a bit of a mess ensues.
Let's say Apple goes for 1280x960 (so it hits the horizontal dimension of 720p). Apple then has 2 choices when it comes to existing iPad apps:
The shrink approach will maintain pixel-perfect rendering. Everything will be sharp and crisp. But because the physical size will be smaller the touch targets in the UI will be smaller -- buttons, menu bars, everything -- and that will cause problems for users. Capacitive touch screens favor big, easy to hit targets. Shrunken apps don't work as well.
The stretch approach has the opposite problem. UI elements stay the same size so are as easy to hit as before but because the change in pixels isn't exactly double the art needs to be interpolated and so edges blur and you lose the crispness. For fast moving games or videos it won't matter. For anything with line work, grids, borders, etc. it will matter a great deal. Stretched apps don't look as good.
Neither option seems ideal and Apple seldom settles for less than ideal options. Historically they just wait until they can do it properly. So while I'd dearly love a Retina Display on iPad 2, my guess is if we don't get it Apple will stick with 1024x768... for now.