HI mygameindexdotcom, yes we have almost concluded that this is a Google issue, because we have found that installing the default translator, provided directly from the Google translate site itself, is producing some of the same translation issues on numerous, but not all sites. There is probably some issue of theme conflicts using lots of custom scripts as well.
The reason the flags work in the plugin is because we use a custom function to access the translations, which somehow bypasses Google's default function.
I urge you not to take my word for it, but to go here and try to install the basic version of Google Translate from their website, while fully removing our plugin: http://translate.google.com. You will see what I mean.
My premium version of the plugin uses custom methods of accessing the translations for both the flags AND the drop-down, when using the custom theme I provide in that plugin. If you are interested in purchasing, the plugin is $12 and you can see a demo of it here http://www.wordpress-studios.com/how-it-works/.
But you don't have to purchase it, you can just use the flags functionality for now and you will be fine.
I think Google made some type of update just last week and this has only been causing issues since then. I'm sorry to deliver bad news!
Thanks so much for using the plugin.