I need to post about this again because life was just getting impossible on my cheapo virtual box. Well, I say cheap but it probably still has 75Mb of free memory that was just being hosed by RubyGems.
I tried updating to Ruby 1.8.7 but that had no effect because the culprit is really Gem itself.
The final solution (after naturally getting off 1.8.6, do it today…) turned out to be building and installing Gem from the 2.0 source tarball. Since getting away from 1.1.1 my Gem experience has been a lot smoother. Ramaze and the monsterous Merb installed smartly and without fuss. Don’t suffer for longer than you have to!