I will admit that "Cloud Computing" terminology is becoming confused. People are mixing together the concepts of commodity hardware datacenters, the benefits of virtualization and massively parallel systems into a blender and calling it a "cloud." The truth is that these three concepts are very disparate practices that often do not entirely co-exist. Most service providers will pick one or two of the three for their managed cloud hosting.For example: Amazon AWS is largely a traditional infrastructure provider that leverages a massive number of commodity hardware (well, not quite, but bear with me) to offer low-cost server hosting. This allows you to spin up elebenty kabillion instances on the cheap, but the price/performance ratio many times just isn't there. A great article was recently published showing how moving a conventional Drupal installation away from AWS provided much better performance, lowered response times and was much more cost effective, even when accounting for disaster recovery. This demonstrates not how physical hardware is more cost-effective, but instead shows how performance matters when calculating cost.
When architecting an application's infrastructure it pays to remember that performance does not increase by adding more servers into the mix. Diagonal scaling is the best way to handle increasing load on a cost-effective basis, as demonstrated by Flickr and Wikimedia. Increase your hardware until you become constrained by concurrency (such as context switching, thread contention or mutex waits) or I/O then consider scaling out horizontally. Unless you are talking about massively parallel algorithms you don't need to spin up an enormous number of machines; even if you do start talking about massively parallel computation, you cease talking about infrastructure as a service and virtualization and instead move towards deploying Hadoop clusters across many physical nodes.
I would agree that vertical scaling isn't a great strategy. I would also argue that horizontal scaling on its own isn't a great strategy either. Get your money's worth for each instance you start, then keep deploying as demand increases.

Last night's episode of This Week in Cloud Computing
Every year during the months of June and July the Midwest gets hit with tremendous storms in the late afternoon to early evening. If you have never experienced this type of weather pattern, it is quite alarming. It can be sunny and ninety degrees while sitting at work or spending time at the pool with the kids when dark storm clouds roll in and strong winds blow across the hot blacktop. If there were tumbleweed lying around, many suburban neighborhoods would look like an old western shootout.
It's almost funny. California doesn't like Arizona's controversial new immigration law. California threatens to boycott all things Arizona. Arizona retorts something along the lines of "Fine, guess you won't be wanting our electricity, either!" Yup, Arizona supplies the power for 25% of Los Angeles. Checkmate. End of story. Plucky little Arizona nails Goliath right between the eyeballs.
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Because we needed another "top" list, I'd love to go through David Linthicum's latest list, "Top 5 Cloud Computing Predictions for 2010."