I was thinking more like Cannibalistic Hillbilly Dwarves = H.G. Wells' Moorlocks from The Time Machine (With Elves conveniently becoming the Eloi...)
Yeah, well Morlock also equals goblin. And as for your elves as Eloi conception, it may be that elves in some sense inspired Eloi in the first place. The fey connection to the Sylvan and the horrid appearance of the Cthonic races are by no means recent archetypes. They influence just about every conception of the alien, so that - whether the result of conscious archetype dipping or not - the result is Vulcan = Elf and Klingon = Orc.
Machinery is also 'goblin' in nature. Consider Tolkien's cannonical description:
Now goblins are cruel, wicked, and bad-hearted. They make no beautiful things, but they make many clever ones. They can tunnel and mine as well as any but the most skilled dwarves, when they take the trouble, though they are usually untidy and dirty. Hammers, axes, swords, daggers, pickaxes, tongs, and also instruments of torture, they make very well, or get other people to make to their design, prisoners and slaves that have to work till they die for want of air and light. It is not unlikely that they invented some of the machines that have since troubled the world, especially the ingenious devices for killing large numbers of people at once, for wheels and engines and explosions always delighted them
- The Hobbit
Consider also their appearance in 'World of Warcraft', where not coincidently, they are also played for laughs.
I think it will take heroic effort to make an ugly degenerate dwarf the object of fear. I think you might end up with Cannibalistic Gully Dwarves at best.
I recognize that this is a departure from your conception, but I think I'd rather be going toward that best ideas of the dour compassionless Duergar combined with the best ideas of the Warhammer Chaos Dwarves, and meld them together in some sort of cthonic 'great old one' worshipping cult, possibly modeled after either the cthonians (Shudde M'ell?), or Abhoth, or Byatis, or Tsathoggua.
Mechanically, I'd introduce anarchic energy taint, and some sort of stone that the dwarves had tunneled into. Essentially, this would be identical in nature to radiation of the fantastic sort, and once the PC's had been exposed to enough to recieve a dose, various effects would begin to occur: sickness, mutation, weakness, etc. Different areas would have different rates of exposure. The mining of this radioactive stone, and the utilization of it in monsterous machines of various sorts would be their principal occupation. The dwarves themselves would employ monsterously mutated versions of themselves as shock troops (I'd probably base this somewhat on the old hordling table in the 1e MM2), while those that had mutated mentally into 'psionic' dwarves ruled over them. The central trait of these creatures would be their coldness, hard-heartedness, and pitilessness. I would have them attack in eerie silence, never being induced to speak, never answering any complaint or petition, never even showing kindness, warmness, or tenderness to their fellows or indeed concern of any sort.
I think 'decrepid decayed byzantine society' you might be able to pull off as a source of horror. I think 'redneck' will only manage dark comedy.
The leathers, the fats for candles & lamp oils, and so forth- all derived from their kills.
The Duergar deity Abbathor does this. If you want to introduce some Gygaxian tension to the setting, there could be a sect of the dwarves that still follow the old ways of Abbathor and Laduguer and who strive to remain free of the chaotic taint that has overwhelmed their fellows.