It is affecting me no more since I switched to debian squeeze. :/
I cannot reproduce this bug now.

Btw, current debian grub-pc 1.98+20100804-13 works for me.

% sudo dpkg-reconfigure grub-pc
... config, select /dev/sdb7 as install device ...
/usr/sbin/grub-setup: warn: Attempting to install GRUB to a partition instead 
of the MBR.  This is a BAD idea..                                               
                                                                               
/usr/sbin/grub-setup: warn: Embedding is not possible.  GRUB can only be 
installed in this setup by using blocklists.  However, blocklists are 
UNRELIABLE and their use is discouraged..
Installation finished. No error reported.
Generating grub.cfg ...
Found background image: /usr/share/images/desktop-base/desktop-grub.png
Found linux image: /boot/vmlinuz-2.6.32-5-amd64
Found initrd image: /boot/initrd.img-2.6.32-5-amd64
done

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https://bugs.launchpad.net/bugs/430950

Title:
  grub-pc package update fails on grub-setup

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