Hawaiian uses ' as a proper letter, granted.
None of this detracts from the greater point, being that we need a way for all writing systems to somehow squeeze down into the subset of ASCII supported by legacy protocols.
But then again, when you invent something, you decide how it works, and the world could just re-invent a more international version of DNS but chose not to.
Also, ASCII is still probably the best charset to use, if you have to choose one; it can represent most possible sounds in some way and symbols represent single sounds (as opposed to, for example, chinese characters). It's very widely used (as opposed to, for example, the greek alphabet).
So yes, limiting DNS names to 26 latin characters and 10 arabic digits was probably the best option at the time.