Official Gmail Blog: New in Labs: Inserting images:
Well, it's about time. You no longer have to use workarounds to put images into your messages or attach images when you really want to inline them. Just turn on "Inserting images" from the Labs tab under Settings, and you'll see a new toolbar icon like this:
Make sure you're in rich formatting mode, or it won't show up. Click the little image icon, and you can insert images in two ways: by uploading image files from your computer or providing image URLs.
Keep in mind that Gmail doesn't show URL-based images in messages by default to protect you from spammers, so if you're sending mail to other Gmail users, they'll still have to click "Display images below" or "Always display images from ..." to see images you embed.