PARIS -- Backwhen he was a rising foreign-service officer based here, John Kelly was noted for playing a melodious acoustic guitar and possessing a wicked sense of humor. I see from his latest testimony to Congress that the sense of humor is intact.

Kelly is now the assistant secretary of state for the Middle East, a policy-making job where a sense of the absurd is more important than a key to the executive washroom: consider Kelly's deadpanning to a Senate committee that U.S. sanctions against Iraq would impair ''our ability to exercise a restraining influence on Iraqi actions.''

The missing punch line came almost immediately from Baghdad. President Saddam Hussein not only repeated his threat to incinerate and poison half of Israel but expanded his rationale for doing so.

The Iraqi tough guy had already said he would release his chemical demi-Holocaust in response to any Israeli aggressive action against Iraqi territory. After Kelly spoke of America's ''restraining influence,'' Saddam said an Israeli attack against any Arab state would trigger the flight of missiles that are Saddam's airborne version of Hitler's ovens.

Some restraint. Some influence. Without such finely tuned American statesmanship, Saddam might well be promising to destroy all of Israel. By opposing sanctions, Kelly presumably got the Iraqi to limit the destruction to half of Israel. The difference to be split with Saddam turns out to be Israel.

Attentive readers will have recognized Saddam as the man who has violently attacked American policy in the Middle East and demanded that U.S. warships leave the Gulf, who has used poison gas on his own citizens and who is eradicating Kurdish villages and tribesmen from northern Iraq. But Kelly neglected to mention these particular effects of his ''restraining influence on Iraqi actions'' when he testified against a moderate, well-balanced sanctions bill for Iraq before the Senate Foreign Relations Committee on June 15. The two instances he cited of Iraqi responsiveness were revealing:

''One step, for example, was the expulsion of the Abu Nidal gang, a group of terrorists,'' Kelly said. But intelligence sources report that Saddam has recently allowed Abu Nidal to reopen a Baghdad office. In real life, government inspectors would demand a product recall for a car or baby crib as faulty as Kelly's statement turns out to be. In bureaucracy, it is different. The State Department, no doubt, is drafting a declaration to explain why the reopening of the Abu Nidal office proves that Washington exercises a restraining influence on Saddam.

''Kelly also noted that Iraq cooperated with Arab League efforts to end the fighting in Lebanon,'' according to a State Department description of the hearing. Well, yes, sort of, in a very Iraqi way.

That is, Saddam pumped tanks, ammunition and other weapons into Gen. Michel Aoun's renegade army as long as it looked like it was winning. Then Iraq supplied weapons to Aoun's rival Christians when their fortunes improved. Iraq's policy in Lebanon, like that of Syria's, is simple: Fight to the last Christian. By egging all sides on, Baghdad joins Damascus in working for the peace of the graveyard in Lebanon.

One is tempted to conclude, not to put it more strongly than that, that the Bush administration has turned a blind eye to Iraq's continuing crimes and misdemeanors in the Middle East, just as Washington long turned a blind eye to the financial manipulation and corruption created in the United States by Iraqi misuse of $1 billion in U.S. agricultural commodity credits.

The FBI investigation into the Lavorno banking scandal, named after the Italian bank involved, shows that the Iraqis carefully studied and targeted the U.S. banking system and then bribed their way to big loans on the strength of the commodity credits. The details still to come on how these loans helped finance arms exports will be even more devastating.

The biggest of principles is involved here. If the United States does not respect itself, how in the world can it exercise any influence over people like Saddam Hussein? He walks up to Washington time after time and delivers it a punch to the nose. Then as he walks away the bureaucracy pats Saddam on the back for his moderation.

Kelly told the senators that sanctions would be ineffective because other Western countries would continue to sell to Iraq. Perhaps. But the Lavorno affair shows that profits from doing business with this deeply indebted, war-ravaged country are likely to be tainted not only morally but financially. At this point, only funny money is to made off Iraq, with fraud involved somewhere in the chain of transactions.

But the whole relationship the Bush administration has developed with Iraq is based on fraud. A policy that requires conscientious officials like Kelly to shade and avoid the truth, to speak no evil of a completely evil regime, cannot be the basis for effective diplomacy or for the self-respect a nation owes itself.