I've been pondering this very thing, but I'm opting to wait for the iPad 2 since I don't already have a netbook sitting around.

If I did, I'd keep it really simple:
1. Cloud Antivirus or something else lightweight and adequate
2. Chrome
3. Skype for video chat with the grandparents, if applicable. Plus, it promotes pan-generational computer literacy

Mostly, I'm just going to use it to play movies/hulu/netflix on the go. I spend a lot of time in the car with my 3 year old, and it's the most productive use of her time in that scenario. Since your nephew can read, there's a lot of other interesting potential. Someone mentioned Edubuntu. I'd say just get him Oregon Trail. Or Craigslist the netbook and get him an iPod Touch.

People get too excited about product recalls. It just means the manufacturer has to eliminate or at least mitigate the failure. In this case, Dell will issue Firmware A.02 or whatever and the problem will vanish. Not a big deal.

I've had a lot of product recalls in my life because I drive a car and I have a baby. Apart from a few rare instances from Kodak and Honda, this doesn't mean the consumer gets a full refund and all of the products wind up in a landfill.