Solution:
1) Sync contacts and calendars. Remove all apps from the phone during the sync.
You can print out a list of Applications from iTunes before you delete them, or
look in your iTunes account purchase history for this information.
2) Disconnect the iPhone and erase all content and settings. This can be painful.
You will lose call records, texts, notes, WiFi networks, YouTube bookmarks,
Maps bookmarks and Safari bookmarks. Webclips will also disappear.
This takes a while so now you can work on your computer.
3) Be sure the iPhone applications in iTunes are all deleted.
Sign out of the iTunes Store and deauthorize your computer.
If you're running iTunes 7.7.1 uninstall the program.
Your music will not be affected. I'm using Mac OS 10.4.11.
Following the suggestions of Jamie Hosticka, I also removed the following files:
* /System/Library/Extensions/AppleMobileDevice.kext
* /System/Library/PrivateFrameworks/DeviceLink.framework
* /System/Library/PrivateFrameworks/MobileDevice.framework
* /Library/Receipts/AppleMobileDeviceSupport.pkg
* /Library/Receipts/iTunesAccess.pkg
* /Library/Receipts/iTunesX.pkg
4) Restart your computer and empty the trash.
Download and install iTunes 7.7.0. Sign on to the iTunes Store and authorize the computer.
Under preferences deselect check for updates automatically.
5) Connect the iPhone. Hold down the home and sleep buttons for a few seconds.
The screen will go blank. Two seconds after the screen goes blank release the sleep button.
Keep the home button depressed to invoke DFU mode.
iTunes will prompt you with a window that it detects the phone in recovery mode then you can release the home button.
6) Set up like a new phone and install the latest firmware. Do not restore a backup.
7) While this is going on you can download some apps on the iTunes Store.
Apps you have already purchased can be downloaded for free.
Another culprit in this bug could be the number of downloaded apps installed to the phone.
Some have suggested limiting the number of home screens to three or less to minimize problems.
8) When the device is finished setting up you can sync your contacts, calendar, playlists, and new apps.
The more apps you have installed the longer the backup process will take.
You may choose to skip the backup until you actually have data on the phone to back up.
Worked for me.
The problem resides within the syncing process between iPhone 2.0 and iTunes 7.7.1. Downgrading to iTunes 7.7 actually cures this issue.
Hope it helps ...
R-Fly