See my iPhone thread for a video of how that works.
I was thinking about this:
You would still use the touch/iphone for control but video would also be on another screen.
Right, that is the best of both worlds. I have the AV cable and when you play a video on the iPod, you get the video on the TV and you get a control screen on the iPod. That's the best way to do it IMHO.
Put a couple of control buttons on the iPod screen and the results on the video out.
I really don't know if that is possible on this generation of iPods/iPhones, but it certainly is possible on some of the netbooks or Windows phones.