I had the same issue with my new iPod 4gb nano. To be perfectly honest, I fixed it and I'm not exactly sure what part of the process actually did the job, so I'm going to attempt to explain it as best I can.
Basically I bought the nano to replace my 160gb classic aka paperweight. I'm currently deployed and the thought of traveling back to the US without a portable music player made me shudder. Within 4 days new nano click wheel decided to do the whole dying thing where I could click the buttons but not scroll through my music/change volume. I took the defunct iPod back to the BX and they exchanged it. I got home and discovered the "new" one they gave me was actually one that had been returned..because it popped up as "josh's ipod" when I plugged it in. So I'm on my third device and you can imagine when my computer informed me said device was corrupt and couldn't be read by my computer..I was pretty peeved. It took 7 or 8 tries to get the new nano update to install on my slow connection and when it finally did..I got the message that the files were in use by another application and couldn't be restored. I restarted the computer, made sure all other applications were shut down, checked my virus software. No dice. I ejected the ipod from my computer, plugged it back in and went into itunes preferences and clicked on "reset sync history". I think at this point it then treated the iPod as if it had never been plugged into my computer before. I then attempted the restore again, it did its thing and I now have a nice, new functioning iPod.
