I came across the recommendation to use the DisplaySize option from this link:http://www.kingcot.eclipse.co.uk/unichrome/unichromeTvOut.html
Upon further investigation you can find a description of the problem in the xine documentation.
Unfortunately, it doesn't fix the problem inside of LMCE. I'm glad sharlee_angelo clarified that the problem is related the Xine_Player. The funny thing is that I'm about 90% sure that I eventually got the playback to work correctly in of LMCE 1.0. I was playing with the custom deinterlacing options, and about that same time it started working. The Xine_Player may not support the API to change aspect ratio, but I'm wondering if there are other options that are supported that essentially produce the result we are looking for.
Currently with 1.1 Beta2, HD recordings are displayed correctly on my 16:9 TV, but SD and DVD's get squished horizontally. I hope this one gets fixed soon. The work around is to watch your recordings through the Myth Recordings screen, but that's not as convenient. It also seems to work if you play content back from MythVideo.