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The P.L.O. has now accepted Israel's right to exist, and the U.S. -- in its own contribution to the finale of 1988 -- has accepted that acceptance. But Israel's new government is steered by Likud's Yitzhak Shamir, who refuses to budge from one inch of the West Bank. If only his position on that key issue were a little more ambiguous. The recent diplomatic progress between the Arabs and the U.S., however welcome, could still end up being a sideshow to the tragedy of the principals passing in the night. As the P.L.O.'s leaders are becoming less rejectionist, Israel's are becoming more so. Israel may be undergoing a self-transformation of the wrong kind.