So the engine started and ran well after reinstalling the Heat exchanger? What's the water flow like out the exhaust? Are you sure the Thermostat opens? Did you change out the impeller while you were at it? Do you have an infrared thermometer by any chance? My water pump gave up the ghost after 32 years, but I'd just double check
the easy stuff 1st.

 

Raw water impeller
Exhaust elbow
Check those

 

How's the flow at the transom?Pull the hose from the elbow. Good flow into bilge? Careful it can be pretty hot Gauge shows temp drop? Elbow is plugged. No flow ? Look at obstruction upstream .Impeller blades ,Plastic bag sucked into inlet. a clam growing in the thru hull. ? Ask me how I can list these so easily.

 

Vapor lock in the coolant circuit, after refilling? Can you see coolant being pumped back into the reservoir (if there is one)?

How long was “really fast” for the new gauge to get to 220? If almost immediate, it may not be correct.

 

It sounds like a mismatch between sender and gauge to me, if the temp goes up ridiculously fast. It would take a diesel at least a few minutes to overheat if there was no cooling. Don't believe everything a salesman tells you. If I remember, the Faria series of gauges will not work with any other sender and vice versa.
If you have plenty of water going out the stern, your problem it isn't in the seawater system. You can completely remove the thermostat if necessary, it is only really necessary if the water is cold.
You should see water in the fresh water circulating if you take the cap off. Put a thermometer in. It shouldn't be anywhere near 212 even if the gauge says it is, shortly after starting. You could check the fresh water circulation pump by removing a hose higher than the pump in the system.
With a 40 year old diesel it is possible that some of the water passages could be restricted with scale from rust. There are probably cleaners available, though may require an acid bath, which means removal. But that could be a good thing as you could rebuild the engine and have a virtually new engine for less than a new one.

 

So, some clarifications. Tons of water out of the raw water circuit on the transom. No blockages there. Raw water pump impeller is new. Both old and new sender units were Faria, I'm inclined to burn $35 and just buy a Faria gauge and see if it works. I don't think I have any cooling issue, I think more and more it's a gauge issue.

I pulled the fresh water cooling pump because when I was in there opening up the vent on top of the thermostat housing to eliminate vapor lock as a potential cause, I noted that there was steam coming from somewhere around the water pump. Steam visible with flashlight above pump, none visible below pump. Took off belt and pulley, looked to be gently steaming from pump shaft seal. Tough to say for sure but the steam was coming from somewhere. There was a squealing sound before the engine overheated, maybe from this pump, there's a bit of squeak/binding when you turn it but no grating sound or feel. I'm going to pull the trigger on a new one, it's a PITA to get to this stuff and it's off now.

Is it feasable for me to have the old pump rebuilt with new shaft seals? Can't imagine the seals cost much - new pump is just under $500 CDN so curious if it would be cost effective to rebuild vs. replace. Who would do this type of work?

 

If the raw water pumps seals are just leaking, it’s very unlikely that’s causing your overheating indication. You may we’ll be right that it’s the gauge, especially if it shows high temps long before the engine could have reached them. I think you said “really fast”.

I’ve had little luck rebuilding pumps. Never lasts as long as the original. Consider buying a new one. They are a wear item.