The message probably means that the partitioning is incorrect.

See, for instance:
http://support.microsoft.com/kb/q229154/
"Your Computer Does Not Have Enough Free Memory to Defrag the Drive" Error
Message

You can see the number of clusters (or "Allocation Units") by running CHKDSK
from a DOS prompt.

The problem is with the total number of clusters (allocation units) on
the 160 gb hard drive, as Jeff Richards said.

Scandisk and Defrag cannot operate on drives with more than 4.1
million (2 ^ 22) total clusters.  

Your 160 gb drive should be OK if you are using it as a 137 billion
byte (= 128 binary gigabytes) provided the drive is using a 32K
cluster size, which is the maximum supported on FAT32.

However if you used a disk cloning utility to transfer the contents
from an older smaller hard drive to the new one then there is a
possibility that the new drive ended up with an 8K or 16K cluster
size, resulting in too many clusters for Scandisk and Defrag to cope
with.

If that is the case, and CHKDSK will tell you if it is when it reports
the total allocation units on the drive and the number of bytes in
each allocation unit then you can fix the problem without too much
difficulty.   All you need to do is to use a disk partioning utility
such as Partition Magic (Symantec) or BootItNG (www.bootng.com) to
change the cluster size of the existing partition to 32K which will
reduce the total number of clusters thereby allowing Scandisk and
Defrag to operate properly.

Note that changing the cluster size will probably require a
considerable amount of processing time during which you cannot turn
off the computer or use it for any other tasks or functions.  And
because any change to the hard drive data structure does involve some
degree of risk you should ensure that you bave backups of any and all
valuable data before you attempt it.

Good luck

Ron Martell     Duncan B.C.    Canada