Jesse Walker suggests three basic steps the Democrats can take to appeal to libertarians. Executive summary: get serious about peace and civil liberties; leave smokers, gunowners, and the politically incorrect alone; and at least consider ways to further progressive goals without using state power.
The first point seems to me the most important and most likely to be effective: as Jesse points out, Democrats are supposed to be good on civil liberties and war. They wouldn't have to re-brand themselves here, just live up to stereotype. As far as the second point goes, the Democrats do seem to be getting the message on guns — gun control is no longer something they campaign on nationally. (And when it was an issue they could campaign on nationally, a critical mass of Republicans was on board too — the 1994 assault-weapons ban had bipartisan support.)
In the short term at least, the Democrats have good political reasons to take Jesse's advice: if they can avoid seeming anti-military or weak on defense, opposing the war more forcefully might serve them well. And while polls show that most Americans don't care at all for the civil liberties that are being infringed by warrantless wiretapping and data-mining, I suspect that the intense minority that do mind have more electoral punch. (Few voters will cast their ballots for Bush's party specifically because they approve of his domestic snooping; rather more will vote against the GOP out of opposition to it.) Halfway pure libertarians are electorally negligible, but the anti-war and pro-civil liberties interests should be significant enough to be worth courting.
In the longer term, however, something very disheartening indeed seems to be taking place: neither right nor left has much of a libertarian wing any more. Libertarians — Rothbard, for example — could see some signs of hope in the early New Left, and while it ultimately came to very little, at least it was a large movement that libertarians could try to influence. The anti-tax, anti-regulatory Right from the time of Proposition 13 to the 1994 "revolution" also seemed like an electoral force with which libertarians could find common cause and perhaps steer toward a more principled and thorough anti-statism. We've seen how that has turned out.
Both the New Left and the anti-Washington elements of the New Right were willing to question the Beltway consensus in a way that could have been productive for libertarians. What gave both movements potential was that they were radical — in criticizing militarism, the New Left didn't care if they were perceived as anti-military (in fact, they largely embraced that perception) and the tax revolt, get-Washington-out-of-our-toilets guys didn't much care how uncouth and politically incorrect they seemed to the national media and political establishment. They still don't care how uncouth and politically incorrect they seem, but now their anger is directed more toward Arabs and Michael Moore rather than the government. I don't see that changing anytime soon. Nationalism and the culture war have gone a long way toward replacing whatever quasi-libertarianism there once was on the Right.
As for the Left, you have Peter Beinart and DLC-types making the case for a more nationalistic, less libertarian Democratic Party, and it seems that given their money and media influence they may win the day against the antiwar Left. But even the antiwar Left is hardly organized and tends toward a great many anti-libertarian positions outside of the narrow question of Iraq — they're not so antiwar when it comes to Darfur, for example.
The early 21st-century political climate in the United States pits resurgent nationalists — whose overreaching may bring them disaster this November — against burnt-out socialists, who no longer want to nationalize industry but who are still heavily against economic freedom. (And while there's some merit in their criticisms of corporations, Eliot Spitzer is no answer to the problems of state-conditioned capitalism. Certainly he's no libertarian answer.)