This is more of a memo to myself than anything else:
The solution is here:
1) Make a static playlist called “All Live Files” and copy your entire library into it.
2) Make a smart playlist called “Missing Files” with the rules set as ” ‘Playlist’ ‘is’ ‘Music’ ” and another rule set as ” ‘Playlist’ ‘is not’ ‘All Live Files’ ”
3) Select all songs from “Missing Files”; they should all be flagged with a “!”, then use shift-DEL to remove them from your library
Worked with iTunes 10.1 under Windows just now.