I think you're leaving out the fact that an iPhone sized device with desktop capabilities is still going to require exquisite integration and interface, the very qualities iTouch devices have today in excess. Raw processing power doesn't change that, it only adds to the advantage.

Everyone gets distracted by the phone. The phone is just an app (and some extra electronics). The platform is the thing, and Apple is light years ahead of the competition at this point. Use a Kindle. Then use an iPod Touch.