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Actually, I had a nice surprise with my smart playlists recently. It's a different issue than yours. My iPod is a 2G model which has never had the ability to update smart playlists on the fly as do the more recent models. It only updates the smart playlists when the iPod is synched with my Mac, which works fine for me.

My nice surprise, however, came with the recent update I made to my iPod Shuffle. Previously, the Shuffle would report the updated play count to iTunes, but would not give a last played date. This didn't work with my smart playlists that rotate songs based on the last played date being several months ago. Last night when I plugged in the Shuffle, I noticed that the songs I had played now all had a last played date set to when I did the synch. Good news for me!

I can see, though, how the problem you report would be very frustrating.

I once encountered such issue. Maybe not in the same context :

When my iPod was not bound to my mac, I mean when it held its own library that I filled in manually, its smart playlist were... smart indeed. They updated themselves automatically.

Then I bound the iPod to the mac, for too many reason to explain here. The smart playlists stopped being smart, everything was just as if they were snapshots of what was in iTunes when I last synced.

I admit it's painful. But maybe, if your iPod is bound to your mac, should you go to manual mode again. Hope this helps.