Hey ponk - welcome aboard.
First things first: don't worry! I'm a US citizen, but my passport clearly says I'm from Iran, my name is very middle eastern, and I have an Islamic background. That said, I've never encountered ANY trouble traveling in Europe. The only time I've gotten any crap was in my home country - in multicultural New York, of all places...
Second: If you wanna smoke your head off (tobacco-wise) you're fine ANYWHERE in Europe - except maybe Ireland, where you can no longer smoke in pubs. 'Cuz you'll be surrounded by cig smoke everywhere you go! But I have a feeling you're seeking herbal remedies, in which case, get thee to Amsterdam, young man. It's also legal in Switzerland, but you said "tight budget," and as far as I know, you can't do anything on a budget there! But pretty much anywhere you go, casually ask a fellow backpacker (not strangers!) if they can hook you up.
Third: I'll be there in Amsterdam from July 9-12 if you want to say hi (and smoke your head off...)
Fourth: A lot of TPunks will be in Spain - around July 7th for the Running of the Bulls in Pamplona, and some of us in Barcelona the week after - Check out the get-togethers and registry threads.
Fifth: You can get this net-type thing that goes all around your whole backpack if you're worried about security. Although the general advice I've been seeing lately about nets and locks is that they scream "I'm valuable! Steal me!" If you're worried about security while your backpack's in the baggage hold, then the cable-tie's the way to go - but remember that airport/airline security can cut it if they feel the need to.