Biology and psychology are very closely linked to the point where they are often indistinguishable. I can understand that dwarves may have genital dysphoria of some sort, but what is there that they can really do about it? Acting as the opposite gender would be acting the same for them.
Would you not consider a condition that leads to desire to mutilate one's genitals, or even commit suicide, to be some form of disability? Manic depression is certainly considered such, as do various problems involving delusions. Of course, hormone treatment or even operations may be the best treatment for this, but it is still something that must be treated.
wow...
It's not a mental illness. No one wants to "mutilate" their genitals. It's not like one day you realize you are transgender and you hack off your penis. It isn't the biological differences that cause one to commit suicide. One does not realize they are transgender and then get suicidal. The issue is the complete and utter rejection of their gender by family, friends, society, violence aimed at them and general bigotry.
Hormone therapy and surgery (which many people choose not to undertake, not including those that identify as genderfluid and don't want an assigned gender at all) only make one's genitals match the rest of them, which helps one feel complete, and prevents a lot of the rampant violence against you.
I don't feel you are in anyway qualified to make a statement about transgendered individuals being mentally ill. The APA would disagree with you, and they are more qualified.
But hey, don't let that get in your way. Massive leaps in logic and base, uneducated conjecture are a great way to learn.