Hi fatcap,
I've lost track of everything that's been tried and hasn't worked, so please forgive me if I'm bringing up some things that've already been mentioned (or tried in some link but not directly shown here).
Go to your pictures in Windows Explorer and right click on a .jpg file that isn't showing properly. Click on Open With and from the subsequent drop menu select "Choose Default Program" and then choose "Windows Photo Gallery" (even if you have to browse to find it which you shouldn't need to do). While there, check to see if there's an option for "Windows Photo Viewer" - but don't do anything with that for the time being (just make a note if it is there - I ask this because that rather than Windows Photo Gallery is the default for .jpg and the others in my system and my thumbnails work and if this doesn't work, we may want to come back and try that if it shows as an option)). Save or OK to set the default and see if that helps. It probably already has Windows Photo Gallery as the default so this may not help - but it's worth a look. If that doesn't work and you do have Windows Photo Viewer as an option, try setting that as the default and see if that makes any difference. I've also read that it may only work if the icons are set at medium or larger - so if set smaller, try changing the view size and see if that helps.
Another option (a bit of an annoyance, but it may work) is to go to Folder Options and click on the general and view tabs to reset them all to defaults. Then reboot. Then go in and make the changes you want to restore them as you want them to be (you'll probably have to tell it not to use files instead of thumbnails again among several or quite a few other changes). Then see if that helped.
Also, check the Default Program Associations:
http://www.vistax64.com/tutorials/83196-default-programs-program-default-associations.html and pay particular attention to Windows Photo Gallery if it is listed. Click on it and then click on change defaults and check to see if the .jpg filetypes are checked as associated. If not, check them and save the changes and then see if that makes any difference.
Finally, you might want to try
Windows Live Photo Gallery 2011 and set it as the default for .jpg files (assuming it doesn't do so automatically) and see if that helps. I believe that's what my system is currently using as the default and is the longer name for "Windows Photo Viewer" that's listed as my default. Again, I don't have your problem so it's difficult to test if this will help, but it might (as it's an entirely new program and that may do the trick). If you don't like it or it doesn't resolve the problem and you prefer not to have or use it, just uninstall it and you should be back to normal.
If it is a thumbnail cache issue and Clean-up is missing the option for some reason, download and install CCleaner
Piriform - Download CCleaner, Defraggler, Recuva, Speccy - Millions of users worldwide! and it includes an option to clean up the thumbnail cache (you can uncheck everything else or run whatever else you want with it - however I strongly suggest you do not ever use any of the registry cleanup options). If it is the thumbnail cache and you can't delete it at present, perhaps this program will do the trick and potentially resolve the problem.
That's exhausts all the options I can come up with short of a repair/upgrade installation. After everything else that's been tried, I'm completely out of other alternatives and quite honestly do not understand why the problem is happening, why it works on your remote device, or how to otherwise repair it.
I hope something here helps.
Good luck!
CCleaner thumbnail cache cleaner has 0 bytes to be removed when analyzed so it looks like there is no thumbnail data stored by windows at the minute (although they must be somewhere as, as mentioned, they flick on and off during fodler refreshes, searches, scrolling etc)