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I'm a newbie at building O/S software, but at least I figured 
this one out (running Cygwin 1.5.5-1 on XP Pro).  Thanks to 
Jason who provided the embed2 patch and helped me 
understand this more fully.

Running on cygwin, if you get the python package (2.3-2), 
follow these steps to get an updated libpython2.3.dll.a 
(and .dll):

cd /usr/src/python-2.3-2
patch -p0 < embed2.diff (attached to this issue, don't use 
embed.diff or pyport.h.diff)
./configure
make
make install (only if you want to install these files)

Now look in the current directory for the .dll.a and the .dll.  I 
was able to build vim 6.2.98 (src also from cygwin dist) with 
an embedded python interpreter with the resulting files (I 
copied the .dll.a to /usr/lib/python2.3/config and the .dll 
to /usr/bin).