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I haven't had any problems with XP on the 701 (aside from hard drive space) but it does need more RAM. We put 2G in at work and it flies.
However if you don't upgrade the RAM you have to be a bit considerate of its limited capabilities. Just don't bother with AVG or windows defender. You don't need either of them if you're not routinely visiting shady sites or pirating software and the Eee (and any computer really) runs way better without them.
It's also funny that you choose XP because of the height of windows. Linux makes it dead simple to deal with oversized windows (ALT-Drag) while Windows is a pain in the ass (hacks like virtual res of 800x600 which don't always work like you say). Overall the 701 is way better suited to Linux. Leave XP for the more powerful mini notebooks..