I spent a few hours trying to figure this out. Basically the Kindle just would not connect to my WRT160N – everything else connected fine. It just said “unable to connect to Wi-Fi network”
I tried everything – disabling wireless encryption on the router and so on. Nothing made any difference.
I decided to go for a software upgrade on the Kindle. Out of the box it had version 3.03.
I downloaded 3.1 from here, placed the file on the device via USB and then selected update from the Kindle menu.
This took about 10 minutes to run.
Following the update I was able to connect to the WRT160N with WPA encryption enabled.