A Microsoft insider (with handle "amirm") provides some clarity on the AVS forums, explaining what types of content are allowed over a component connection. If you insist on watching your HD-DVDs at full resolution, it appears you'll have to invest in a VGA cable (and not an HDMI cable).
If your 360 is hooked up via component cables:
- Xbox 360 games can be upscaled to 1080p. Titles that run in 1080p natively (none of which currently exist) will also display without a problem.
- HD-DVDs will display at 1080i maximum -- you can thank AACS for that.
- Normal DVDs will play at 480p. CSS prevents anything higher (though some upscaling DVD players conveniently ignore it).
- HD-DVDs, Upscaled DVDs and games can all display at 1080p with no copyright hassles.
- You have bigger problems.