Thank you ogami_ito for starting such a useful thread. I just really wanted to share how I got over the stupid glitch because I was really at wits end trying to figure out why my phone wouldn't even connect to my computer. Some of the readers who happen to stumble upon this might find it useful.
1. Uninstalled Samsung Kies. I was told by a friend to uninstall the latest version I have and instead of updating the software through the Samsung Kies itself, download the latest version and install that. (I'm not really sure how much this contributed to my success, but hey it was worth a try).
2. Connected Galaxy S in Samsung Kies mode and uninstalled the MTP device drivers through Device Manager. Closed Kies, and reconnected phone. (Nothing really happened at this point. I still got the same error -- saw a bright yellow splat on the device in Device Manager still).
3. Downloaded Windows Mobile Device Center. I figured this would maybe download some drivers that my device would need to connect it to my computer. I'm not sure how much this step helped though because the phone still refused to connect to Kies.
3. Unmounted the internal SD card then connected device in Samsung Kies mode. I saw a considerable difference here. The screen on the device itself stopped flickering. I noticed that when I first started all this, it would say "Initialising" on the device and "Connecting" on Samsung Kies. It would then sort of flicker or refresh, then go to the same screen. At this point, after doing this step, the device stopped doing it. I was really hopeful that it'd connect to Samsung Kies, which it unfortunately didn't. Which led me to:
4. Connect Galaxy S in Mass Storage device mode, copy all files from internal SD card. Unmount internal SD card, wait 5 seconds, format internal SD card. (My heart fell when I had to do this step because it's one of the things that I knew I had to consider, but was hoping I wouldn't have to do).
I put the device back into Samsung Kies mode, opened Samsung Kies on the computer and connected the device. IT FINALLY WORKED.
I've had this phone since February and I haven't really considered upgrading it because it catered to whatever needs I had at that moment. So this is really a refreshing change. I was aiming for Froyo but am happily tinkering with my new Gingerbread device. Hope you guys find your happily ever after too!