It's not smoke or even mirrors. Instead, your GPS-free iPod touch really does use another way to figure out how far you have run and your position. The optional Nike+ sensor that fits in your shoe is basically a piezoelectric accelerometer that works by transducing pressure to an electrical signal so that your iPod can detect the steps you take. In addition, your iPod uses its built-in Wi-Fi technology to provide rough geopositioning.
Apple works with a company called
Skyhook Apple connects real-world coordinates with a huge database of Wi-Fi routers. This database uses scans of city streets to detect routers' local MAC addresses and create a correspondence between those addresses and a real world GPS position. Because Wi-Fi routers very rarely move, that database offers a way that mobile devices can determine your position even when you don't have direct access to GPS satellite technology.
It's a really clever system that's pretty robust. Admittedly, if someone moves from Kansas to Texas and brings their router with them, the system may get confused for a little while but for the most part, bad positioning tends to get fixed pretty quickly.
If you'd like to learn more about iPhone and iPod positioning, you might want to check out this TUAW post from 2008.
Update: Readers point out that Apple has replaced Skyhook with their own proprietary Wi-Fi positioning technology, starting as of last month.