I'm for static animations on flags. It doesn't have to be anything fancy, just a small amount of movement would make them less distractingly static.

I'm also for a toggled cape implementation, which is in almost all MMOs with capes like Guild Wars(which had real cape physics despite coming out only shortly after FFXI, but like many games you can toggle them). That's a topic for another thread but since it was mentioned I thought I'd bring it up.