More specifically, why iTunes isn't reading the EXIF data. The iPod just displays what iTunes feeds it.

The argument that "iTunes isn't a photo manager" isn't valid. It is a photo manager and photo synchronization application, albeit a very simple and limited one. In fact, from what I can tell, it's the only app available for synching photos from a Windows PC to an iPod Touch. It allows you to select (in a very limited way) which photos you want to load, then it processes the photos quite extensively for the purpose of adding them to the player. It pre-creates all the necessary thumbnails and zoom sizes, for example.

Anyway, whether you call it a photo manager or not, that argument doesn't matter.

What does matter is: For the purpose that the photo feature in iTunes is intended (loading the user's photos onto an iPod touch which supports orientation based-rotation), then it is completely logical to expect it to interpret the EXIF data on the photos and do the right thing.