Not sure...the img code works great for links, to put an image in a post from another URL, like I've done with my Photobucket pics sometimes, I'm going to try to copy and paste a picture into this post, just to see if it works.
At any rate, you would have to have a "Browse" button somewhere to use.
EDIT: Nope, copy & paste doesn't work, so apparently you'll have to use photos uploaded to an external site. Photobucket, Imagefap are a couple I'm aware of, others are available I'm sure but can't think of them right now. For those, the IMG button in the compose window just puts the image tags in place for you. I'm so used to doing it myself for URLs and such I never bother, I add them manually, and with Photobucket a preformatted inage tag is already there, just copy & paste it. I'll first add the IMG code with a couple of spaces so it'll show as text, then as a usable link to a pic of my electromuse lap steel.
[IMG ]http://i240.photobucket.com/albums/ff58/paleopete/lapsteel.jpg[/IMG ]
Remove the two spaces before the first and last brackets, here's what you get.
But I don't see an option to upload an image directly from your computer, apparently it has to be from an external site.