I\'m thinking about making a physical controller (device?) with knobs, buttons, and LEDs. I\'d like to interact with it using Java (respond to the knobs, light up LEDs, etc)
For some encoders and buttons, you probably want to implement a USB HID device. If you're going to produce more than a couple of them, you'll want to do a custom board. Check out V-USB, an open-source library for making USB HID devices using Atmel microcontrollers. They have a bunch of examples of projects that use this library.
You could probably make this look like a HID joystick, using the encoders to produce X/Y axis information and having the buttons act like buttons. They you could use standard Java gaming APIs to read the joystick values.