I don't see any reason why they wouldn't release a "nano" iPhone. They released a nano iPod that didn't seem to hurt the business. Why would a nano iPhone?
I suspect that they would put it in competition with the mid-range phones, such as the RAZR and LG Chocolate. My guess is that it would lose WiFi, AppStore, and maybe the robustness of Safari, but maintain the iPod functionality. It would probably be a simple combination of phone and iPod and nothing more. That product would make sense and have a spot in the marketplace.
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