But there was no chance at all that Germany would conquer all of the Soviet Union in one step.
According to most of the historical analyses I've read, Germany certainly might have defeated the USSR conclusively - if they hadn't made mistakes like the 6th Army not retreating from Stalingrad, and if they had succeeded in conquering Murmansk, and if the USA had not started to provide huge amounts of aid to the USSR. They did have a lot of luck - more than might be expected - but it certainly wasn't impossible for them to have a bit more luck and win outright.
Of course they would have benefited from preparing good fallback positions somewhere in the Ukraine which they could hold if the Red Army started to push them back. But they never had the spare time or resources for it. Of course hindsight is 20/20; today we can say they should have diverted resources from the Atlantic Wall which failed to prevent D-Day.
On what do you base your statement that they had no chance a priori of ultimately defeating the USSR? Sure, they didn't have the manpower to actually conquer and hold all the vast territories of Russia, but that wasn't necessary to defeat the Red Army conclusively.
Especially while fighting inefficiently, also fighting in the west and distracting themselves with other things.
The Western Front didn't exist until the Germans were completely defeated in the East. It simply wasn't relevant. (Battle of Kursk was in August 1943. Allied invasion of Italy was in September 1943 and of Normandy in June 1944.)
As for distractions, apart from the tradeoff we're discussing and similar decisions (which I think were at least in principle rational), what else do you mean? Certainly there were many mistakes made, inefficiencies, etc. but nobody's perfect.
But since the nazis kept talking and thinking about the propaganda in 2) as their reason for their actions in 1) they felt that they had an urgent need to continue with the genocide. Even when that hurt their original goals.
I'm sorry, I lost you. The original goals included finding a "final solution to the Jewish problem". Even if ghettos could have worked in the longer term, once it was clear that they risked losing e.g. Poland to the Red Army, they switched to extermination. That way no matter what happened to the Nazi regime, the Jews could not hurt the German people in the future. How does this hurt their original goals?
As Eliezer and many others on Less Wrong have said, the way the human species rose to dominate the Earth was through our intelligence- and not through our muscle power, biochemical weapons, or superior resistance to environmental hazards. Given our overwhelming power over other species, and the fact that many former top predators are now extinct or endangered, we should readily accept that general intelligence is a game-changing power on the species level.
Similarly, one of the key ingredients in the birth of the modern era was the discovery of science, and its counterpart, the discovery of the art of Traditional Rationality. Armed with these, the nations of Western Europe managed to dominate the entire rest of the world, even though, when they began their explorations in the 15th century, the Chinese were more advanced in many respects. Given how Western Europe, and the cultures derived from it, has so completely surpassed the rest of the world in terms of wealth and military might, we should readily accept that science and rationality is a game-changing power on the civilization level.
However, neither of these imply that intelligence, science, and rationality, as a practical matter, are the best way to get things done by individual people operating in the year 2009. We can easily see that many things which work on the species level, or the civilization level, do not work for individuals and small groups. For instance, until the discovery of nuclear weapons, armed conflict was often a primary means of settling disputes between nation-states. However, if you tried to settle your dispute with your neighbor, or your company's dispute with its competitor, using armed force, it would achieve nothing except getting you thrown in prison.
People are crazy and the world is mad, but it does not necessarily follow that we should try to solve our own problems primarily by becoming more sane. Plenty of people achieve many of their goals despite being completely nuts. Adolf Hitler, for example, achieved a large fraction of his (extremely ambitious!) goals, despite having numerous beliefs that most of us would recognize as making no sense whatsoever.
We know, as a matter of historical fact, that Adolf Hitler and his Nazi Party, despite being generally incompetent, unintelligent, irrational, superstitious and just plain insane, managed to take over a country of tens of millions of people from nothing, in the span of fifteen years. So far as I am aware, no group of people has managed to achieve anything even remotely similar using, not only rationality, but any skill involving deliberative thought, as opposed to skills such as yelling at huge crowds of people. However, it is a corollary to the statement that no one knows what science doesn't know that no one knows what history doesn't know, so it is entirely possible, perhaps likely, that there is something I am overlooking. To anyone who would assert that intelligence, science or rationality is the Ultimate Power, not just on the level of a species or civilization, but on the level of an individual or small group, let them show that their belief is based in reality.