Bitcoin is not so bad at privacy as you say. But it's certainly can be made better with fully automated solution deployed on massive scale individually, without major agreement or protocol changes. It's just an evolution of the technology. Ajax apps also did not appear overnight on the web.

That's generally not the case. You might be able to see some of my funds, but certainly not the entire contents of my wallet unless you're using very broken ones. I've hundreds of different inputs in my wallet, and you'd only be seeing one of them.

I think the danger of the public nature of the blockchain is way overstated. It's fairly trivial to introduce reasonable doubt into your transaction history, blockchain analysis is nowhere near as useful to law enforcement as some people think.

The situation I worry about more is when someone is operating outside of the law, for example if you legitimately but unknowingly end up with some coins that were previously stolen, and then some guys with baseball bats turn up at your house.

That's why you split the coins repeatedly as you mix them. You don't want more than 0.1% of someone's "dirty" history. Client-side statistical analysis allows each node to decide which coins are good for them personally. (So that all coins are "far" away from each other.)