Q: Would it erase my photos and music If I pressed erase all content and reset iPod?

yes.

now if you bought your music from iTunes you can always redownload it, but 'erase all content and settings' is just that. It puts your ipod back to its out of box state

Are you talking about erasing stuff off your  computer if you reset all content and settings? That won't be affected. It's the iPod that'll be erased.

If you are backed up to icloud, then its ok to erase all content and reset ipod.

Just note that the iclold backup only inlcuded iTunes purchases. It does not inlcuded music from CD (unless you have iTunes Match) or photos synced to the iPod.