Islamic Militancy can be as much as a threat to the Muslim as it is to us. Bin Ladin's wahabbism has caused him to define Islam into a "we're it" mentality and if he does not think your Islams measures up, you are apostate and worthy of death.
So in the sea of Muslims not all of them are our enemies. But, its easy to deceive ourselves, to thinking that automatically makes them on our side. It does not.
Muslims are taught that Islam says that we are to dominate and not be dominated and since we are dominated something horrible has gone wrong. What could it be? Well, the fault does not lie with Islam because it is perfect, therefore, the world has been turned upside down and works to keep us pinned down. So, whereas not all Muslims are putting on suicide vests, they do think that we are responsible for their decline, so when Israel is attacked or the US, they think it is justified.
As Mark Steyn points out in his book, Europe is about to taken over without firing a shot, and they can't seem to find the will to rouse themselves and prevent that from happening. You are absolutely right when you say we are strait jacketed. It is our own invention but now we seem to think it is now our identity. That cultural relativism is the foundation of our civilization, and it would be a horrible if we set it aside.
Now, we play the diplomatic speak game that you suggest but all it does is weaken us in the militants eyes. This culture understands only strength. So be strong.
We have been. Iraq for all its problems is a winning proposition for the West. We should not ignore the hope in democracy that the Iraqis have and should continue to nuture this budding democracy in the hopes that it will be a light in the dark places and bring about bloodless coups and a cleaning of their own mosques (so to speak) because the alternative is too horrendous to think about.
As to the goodness or not goodness of our role in Iraq; the main thing is that we took/are taking action in Iraq. The main problem is that, on their home turf, not even relatively sophisticated muslims are into team playing. They will turn out to vote for something better but no one in that region is going to learn (non violent) bi-partisanship in a couple of years.
(We learned of it long ago in the USA and still manage to regress all too frequently)
One of GWB's greatest failures was in allowing it to appear that 'democracy' in Iraq would look like 'democracy' in the US. It just might be that they will be able to generate a government that includes all parties in a more or less peaceful forum while the various cults, tribes, and street gangs go about their brutalities at some level below critical mass.
"You can probably trace it back to our arming of the mujahadeen in Afghanistan so they could defeat the Soviets."
Oh, good grief. A few stinger missiles and some small-arms ammunition does not constitute "arming" a country.