If the resolution is corrected, and the characters are too small on icons and in menus, the font and size of the font can be changed in Settings->User Interface Settings.
If the monitor is an LCD and characters are still "fuzzy" turn on anti-aliasing in the same setting menu, see if that helps, then sub-pixel hinting and hinting. Results are shown immediately.
So, why did this happen in the first place? When this Thinkpad ran Windows 98/NT/2000/XP, everything rendered correctly no matter the resolution. But IBM designed it specifically for Windows 98/NT, and it may be that VL and XCFE4 do not have the same access to all functions in the video card as Windoze.
As a Windoze machine with each OS load however it became slower and less and less useful as a computer. In W-XP, networking and virus checking overwhelmed it to the point that it would become useless when connected to the Internet. With VL it now runs great. The first Linux I tried on this machine was Linux-XP which absolutely sucked in terms of configuration and documentation. The screen was horrible at any resolution with Linux-XP.