Originally I thought getting towed with the hubs unlocked was like driving in two wheel drive.
So then I emailed the guys at TeraFlex the makers of the TeraLow Transfer kit. They explained it to me. Whenever you drive the jeep the input gear is always turning. This is rotating gears on every shaft. Even if they are not transferring power they are transferring oil throughout the transfer case. I made this gif to illustrate how the transfer case works. Any gear that is red is transferring power. Any gear that is blue is free-wheeling on it's shaft. Black gears are not rotating. When you shift a transfer case there are two gears you are sliding on their shafts. These sliding gears either lock themselves onto the shaft if they are moved to the front of the transfer case. Or if they move to the rear they mesh with the idle gear.
Four wheel drive low is confusing. Keep in mind the main drive shaft from the transmission is rotating faster than the out rear drive shaft. Power is transferred from the transmission gear to the idle gear and then back to the two drive shafts.
Many other gear driven transfer cases, such as the Dana 300, are made this way. This is why you should always have the front hubs locked when getting towed. Either the front drive shaft
OR the transmission needs to be rotating the gears in the transfer case. The rear drive shaft can't rotate the necessary gears.
This dispels a common misunderstanding.
Lock your hubs when getting towed.