There have been many topics dealing with this issue, and I figured it was time someone made a guide with correct and precise instructions.
To complete this guide you will need to have at least moderate knowledge of Photoshop or similar advanced graphic software. You will also need your PC and some additional software.
However, I can confirm that the results are "as advertised" - full quality wallpaper image, without any visible image degradation.
Please note that I take no responsibility if you mess up something. I suggest you make backup folder with Manila files that need to be edited, so you can always go back to default if something isn't working. Also note that this guide deals with Manila2 (the new Manila from latest Topaz / Rhodium ROM's). The old Manila1 may be using different file names.
If all this seems too complicated, a simple way to improve image quality on your Touch HD is to use 512x512 pixel PNG wallpaper! Do not use 480x800! Use 512x512 and you will see it will be sharper and much better looking. Not perfect, but still better!