As stated too many times to count, the GPL is fine with this. It is nonsense to say that something that the GPL text specifically allows, and something that the authors of the license have been doing since day one, could be against the spirit of the license.
So, that's not your question. Your question is, "if one of the authors of a piece of software chose an inappropriate license, and then after I'd done a bunch of development work based on their code, told me that they wished they'd chosen the 'you may not sell modifications based on this code' non-free license, what should I do?"
In my case, I think that the GPL is a more ethical license than the one he's describing, so I would point out how vastly different this no-selling license would be, and point out that it would not be considered a free software license by anyone (DFSG, FSF, OSI). It can hardly be unfair of you to have thought that, by using a free software license, he meant for you to enjoy the freedoms provided by free software!
In summary:
- if you hadn't done any development yet, I think I would probably respect their wishes, and think poorly of them for choosing such an inappropriate license (without, apparaently, reading it first).
- since you have, I don't think there can be anything unethical about using the license you have, given that you are following both its text and its spirit.