I see that the kindle "passwd" command creates passwords that start with "$1$". According to Wikipedia, that indicates "modular" encryption using MD5 encryption with a salt:
http://en.wikipedia.org/wiki/Crypt_(Unix)
The original default root password does not start with "$", so it uses the traditional DES which truncates the password to 8 characters.
So, it turns out that both of my guesses were correct, as to why user-created passwords behave different from default root passwords.