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Lex Superior
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The flag template by Birger Jarl is making my head spin... :wacko:

Even though I have the displace file on my desktop, it still says "Cannot complete displace because the file is empty" or something... and the flags doesn't turn out very well, even though they are exactly 150*100 as sugggested... some of the edges are cut off, and some of the background edges are visible...
 
You can always load the displace manually. :)

Filter > Distort > Displace

Horizontal Scale: 3%
Vertical Scale: 3%

Press OK and load your displace file.

Make a new layer and place it behind the flag, fill it with the same color as your flag you're making and it will look ok.
Oh, and the template isn't really mine more MKJ's and Korath's work, I just added some extra goodies. :)
 
To remove the white spots, create a new layer and fill it with the most dominant color from the flag (if the flag is split horistontically I generally take the brush holds Shift and drag a line in the middle of the flag).

I also suggest that you make the new displace a part of the action (and remove the old one).