Gruber complains about a smaller iPhone:

I really don’t think we’ll see screen sizes other than 3.5 inches, unless Apple introduces a new size that developers would need to specifically redesign their apps to properly target — and I just don’t see a need for that.

I have talked about this before and Grubers point got me thinking. What if Apple really isn't making a smaller iPhone, but a smaller iOS device. One that's solely made to control the upcoming Apple TV running the A5 chip.

Apple currently has a lot of remote type apps in the App store (45 for iPhone and 20 for iPad including desktop remote access apps), what if this new cheaper type iPhone is meant to focus on this type of app. Developers specifically build remotes for their apps that runs on the new iDevice. I mean most people don't want to use their cell phones to control the TV, it's a waste of battery, sharing the remote is a problem and switching apps back and forth from the remote is less than ideal.

Requirements

The device would certainly have to be cheaper than the current iPhone and iPod touch, will not need much hard drive space (at least not as much as the iPhone), might not need a home button thats the same as the current iphone (differentiation as the button could be elsewhere on device) and can be used with voice control (easy commands like skip, forward, play). This sounds eerily familiar to what was said in the WSJ Article

In fact as wild speculation, using AirPlay the Apple TV could stream it's screen back to the iDevice and allow control using the touch input along side individual apps.

Only time will tell if or what Apple has planned but this is my best guess on that smaller iPhone everyone is talking about.