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> More fun will arise when my Windows terminal (encoding=cp1252) 
> will try to display Chinese characters. Let's pretend this is 
> yet another issue.
I tried the patch using a script with unicode characters (character 
not representable in ISO-8859-1 like polish characters ł and Ł).
Result in an UTF-8 terminal (my default locale):
 Traceback (most recent call last):
 File "unicode.py", line 2, in <module>
 raise ValueError("unicode: Łł")
 ValueError: unicode: Łł
=> correct
Result in an ISO-8859-1 terminal (I changed the encoding in my Konsole 
configuration):
 Traceback (most recent call last):
 File "unicode.py", line 2, in <module>
 raise ValueError("unicode: \u0141\u0142")
 ValueError: unicode: \u0141\u0142
=> correct
Why does it work? It's because PyErr_Display() uses sys.stderr instead 
of sys.stdout and sys.stderr uses a different unicode error mechanism:
 >>> import sys
 >>> sys.stdout.errors
 'strict'
 >>> sys.stderr.errors
 'backslashreplace'
Which is a great idea :-)
You can try on Windows using the new attached file unicode.py.