I had exactly the same problem as described on my '91 8v, finally spent some time on it last week.
I'd replaced the bypass valves last year, just put a new expansion tank cap on from VW. New water pump and thermostat in September '09
Tried bleeding the system and no difference.
Then connected the matrix inlet pipe up to the outlet side to back flush it and ran the car while lots of very dirty water came out the open inlet side, when it ran clean coolant I connected it back up again, topped up the expansion tank and started to bleed it. Still no hot air.
Then I ran the engine up to 3500 rpm for about 5 mins, quick bleed and now it's spot on, it really needs to be under some pressure to push it all round. Having to run it with the slider more on the cold side otherwise it's too hot. Keep persevering, it's worth it. I know I may need a new matrix in time if the sludge has damaged it but for now it's water tight.
Good luck.