It looks like you've narrowed down your problem to worn out brake hoses. I'll bet the smoking problem will go away once the new hoses are put in. This is a typical failure pattern for brake hoses. The inside wall deteriorates, then acts as a one-way valve, allowing brake fluid to pass through under the high pressure of applying brakes. Then it won't let fluid pass back under the low relaxation pressure, and the brakes can't properly release.
Since you're doing the master cylinder and brake hoses, why stop there? Why not rebuild all calipers? Then the whole system is refreshed.
If the brake fluid is that bad, I wonder what else has been neglected over the years. I too have an old car, and old cars require constant attention. There's not a lot of parts - namely seals - that are still original. I plan on replacing many of them in the near future.
Your car looks great, but you'll have a job ahead of you addressing issues with old seals and gaskets.
95 E320 Cabriolet, 131K