I was very sorry to read about your situation. I have some expertise in this area and believe your son-in-law and his mother may well suffer from a personality disorder or disorders. Narcissistic disorder, however, does not begin to explain what has been going on here. If your telling of the story is accurate (and I have no reason to doubt you) than I would say that all the classic signs of abuse are present. There may well be no physical abuse, but psychological abuse can be just as damaging.
It seems that your son-in-law is influencing your daughter to break off her most important and closest relationships. The only reason I know of why someone would do this, is to have more power and control over the person. By cutting your daughter off from friends and family, your son-in-law is controlling her life and putting himself in an even more powerful position over her.
I understand how hurt you must feel about the way she has treated you, but try and remain open to her contacting you if she needs to in the future. She may feel trapped in this marriage, especially with two small children, but isn't able to see how her husband is controlling her life as i) she is probably very much in love with him and ii) he is probably a master manipulator.
If you close yourself off to her, and she does come to the point where she breaks away from his control and wants to reach out for help, she needs to know that you are there for her. If her husband suffers from borderline personality disorder (BPD), and I strongly suspect this is the case, no amount of rational discussion with him is likely to change things. You'd have to be pretty good at manipulation yourself in order to make him feel you were on his side, really liked him (people with BPD also may have narcissistic disorder/traits concurrently), and weren't a threat to his marriage. That's a tall order and not likely doable even if you wanted to.
I sincerely hope that your daughter reaches out to you before she becomes more cut off from the people who love her. Unfortunately, people with BPD fear abandonment more than anything, and this is why they try to keep their partners cut off from outside influence. The fear is that if their partner has people in her life who give her something objective to compare the way she is being treated or what her relationship is like with, than she will see how disfunctional and abusive it really is and leave them. By convincing her to cut herself off from friends and family, it also makes it harder for her to leave him if she has a "moment of clarity" because she doesn't have a support system to turn to. She may also feel too embarrassed if she has treated these people badly in the past, e.g., not thanking you for the package/gifts you sent.
If she is/was the type of person you believe you raised, than she has to be feeling badly about this on some level. It is painful to watch and do nothing, but other than letting her know that you are there for her if she needs you, I'm not sure what else you can do. This situation almost seems to call for an intervention of some sort, but if she won't see you or her friends, I can't see how that could be planned. I just wonder if being blunt about her husband's controlling ways and possible psychological issues to her might not get her to open up and maybe admit that all is not perfect in her domestic world. Clearly, trying to be nice and non confrontational has not worked. Your daughter may be fluctuating between believing what her husband is telling her, and what her heart is telling her. She may have in effect been "brainwashed" by him and may even be questioning whether or not she is the "crazy one". Gaslighting is something else that individuals with BPD excel at, and your daughter would be even more vulnerable with having had two children in the past two years (fatigue, hormone fluctuation, post natal depression, financial and emotional dependency on her husband, etc.)
I am so sorry I can't be of more help and I really wish you and your daughter the best. The bottom line is that the smaller he makes her world, the bigger and more important and indispensable his role in it becomes, i.e., the less likely she will leave him. It seems like you have been hesitant to criticize her choices in the past, and perhaps she might have married him anyway, but sometimes we need to voice our concerns in order to for our loved ones to see they are making a mistake. If she had someone to validate her concerns about his treatment of her and tell her his actions weren't that of a person who really loved her, but that of someone who was being controlling, then perhaps she wouldn't have gone forward with marrying him. I don't mean to imply that this is in any way your fault, but just that it doesn't help to keep trying to sugar coat things. If you get the chance to tell your daughter what you really think of her husband, you may want to go for it. She may be angry now, but you have nothing to lose if she already has cut you off, and everything to gain if she later decides to leave him. She needs to know that she has somebody to turn to, no matter what, if she comes to that point. She needs to know that somebody else sees what is really going on and that she is not the one who is crazy.
I have lived through a situation very similar to the one you describe and I wish I had someone I felt I could turn to who saw him for what he really was, during my rare moments of clarity. It is very easy to be convinced that you are the one with the problem though if you are in an abusive situation with a controlling partner who has cut you off from outside/objective influences. The longer your daughter is cut off from you, the less likely she is to feel she can turn to you if she needs to down the road.
You may want to check out this site:
Borderline Personality Disorder - Support group for families and relationship partners. You will find a lot of good information there and message boards where you can read about others' experiences. The message board for Coping With Parents, Relatives, or Inlaws with BPD may be particulary helpful. Don't give up hope, and remember that no matter how it looks, your daughter does love you.