vailr: Though I've never tried it myself, I don't think that method works. First of all, if you use xcopy in DOS, you lose all your long filenames. Secondly, while running Windows, not all files may be copied because some of them (especially system files) may be in use. This method will also attempt to copy the current swap file, which I don't think is a good idea. Lastly, whether or not you do it in dos or windows, you don't copy boot record information with xcopy, so even if all the files are copied, the drive won't boot.
I believe there are programs out there to do this... I think Norton Ghost is one of them? (correct me if I'm wrong, fellow Anandtechers... I've never done this before)
There are benefits in reinstalling Win98 though. You may find your computer running faster more stable since you don't have all the crap that accumulated while installing/uninstalling certain programs on your old HD.