Update: See the end of the article for Jeff Bezos's admirably forthright response

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In light of Amazon reaching in to users Kindles and removing their legally purchased copies of 1984 and Animal Farm, the question must arise: Is it legal? A quick visit to the Amazon Kindle License Agreement leads me to believe that nothing in it gives Amazon the right to unilaterally revoke the license assignment without cause. The relevant passage concerning license rights given to the consumer reads:

Use of Digital Content. Upon your payment of the applicable fees set by Amazon, Amazon grants you the non-exclusive right to keep a permanent copy of the applicable Digital Content and to view, use, and display such Digital Content an unlimited number of times, solely on the Device or as authorized by Amazon as part of the Service and solely for your personal, non-commercial use. Digital Content will be deemed licensed to you by Amazon under this Agreement unless otherwise expressly provided by Amazon.

Not being a lawyer, I don't know whether an email notification and a credit to their account counts as 'expressly provided by Amazon' or whether it has to be provided in this license agreement. The tone of the paragraph seems to make it clear though that the assignments of the rights described here are permanent, and are made in trade for your payment. In other words, you bought the rights stated, limited as they may be. On the subject of subscriptions, Amazon has a clear policy of pro-rated refunds for subscriptions that are paid for but cannot be fulfilled (for example, if a magazine ceases publication):

Subscriptions. The following applies with respect to Digital Content made available to you on a subscription basis, including, but not limited to, electronic newspapers, magazines, journals and other periodicals (collectively, "Periodicals"): (i) you may request cancellation of your subscription by following the cancellation instructions in the Kindle Store; (ii) we may terminate a subscription at our discretion without notice, for example, if a Periodical is no longer available; (iii) if we terminate a subscription in advance of the end of its term, we will give you a prorated refund; (iv) we reserve the right to change subscription terms and fees from time to time, effective as of the beginning of the next term; and (v) taxes may apply to subscription fees and will be added if applicable.

But even in this case, there's nothing that implies Amazon has the right to touch the portions of the subscription that you have already downloaded. And books aren't subscriptions. Amazon also makes a clear distinction between the "Device" (the Kindle) and the "Service" (the content delivery mechanism):

The Kindle Device (the "Device") is a portable electronic reading device that utilizes wireless connectivity to enable users to shop for, download, browse, and read books, newspapers, magazines, blogs, and other materials, all subject to the terms and conditions of this Agreement. The "Service" means the wireless connectivity, provision of digital content, software and support, and other services and support that Amazon provides Device users.

This is important because the agreement makes clear that the Service could go away at any time, and you're not entitled to it:

Changes to Service. Amazon reserves the right to modify, suspend, or discontinue the Service at any time, and Amazon will not be liable to you should it exercise such right.

This would be as if you turned off the wireless switch on your Kindle forever. No more updates, no more downloads, but anything on your Kindle would stay. But what if you violate the terms of the agreement?

Termination. Your rights under this Agreement will automatically terminate without notice from Amazon if you fail to comply with any term of this Agreement. In case of such termination, you must cease all use of the Software and Amazon may immediately revoke your access to the Service or to Digital Content without notice to you and without refund of any fees. Amazon's failure to insist upon or enforce your strict compliance with this Agreement will not constitute a waiver of any of its rights.

First, it's clear that Amazon can only enforce this clause if you the customer are in breach of one or more terms of the agreement. If you are, Amazon insists that you stop using the software on your device (the Kindle OS or your iPhone Kindle app) and they may not only revoke your access to the Service but also to the Digital Content as well, presumably by reaching in to your Device and de-authorizing a key. This is clearly not what happened to purchasers of Orwell's books, since there's no allegation that they violated the usage agreement in any way. So what in the agreement allows Amazon to cancel the agreement unilaterally? There's the standard amendment clause, which lets Amazon amend the agreement as it sees fit:

Amendment. Amazon reserves the right to amend any of the terms of this Agreement at its sole discretion by posting the revised terms on the Kindle Store or the Amazon.com website. Your continued use of the Device and Software after the effective date of any such amendment shall be deemed your agreement to be bound by such amendment.

With this clause, Amazon could give themselves the right to take books away, but they would have to amend this agreement in order to do so, and the user would have to then use the Device and Software to give implicit agreement to the amendment. Set aside for a moment the conundrum of an agreement method that effectively says "If you try to read the book, you agree to our right to take it away, and if you don't try to read it then you can keep it." The fact is that if Amazon plans on amending their agreement to allow this, they haven't done it at the time of this article. I freely admit that I'm a layman and not a student of law, so if someone more well versed than I can see what I missed, please let me know so I can update this post. Until then, always keep a backup of your book files on your computer or other media that is beyond Amazon's grasp, so you can at least finish reading a book before Amazon takes it away or refuses to let you download it again (but that's a whole other issue).

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Update: Jeff Bezos left an admirable response on the subject in the Kindle forums:

This is an apology for the way we previously handled illegally sold copies of 1984 and other novels on Kindle. Our "solution" to the problem was stupid, thoughtless, and painfully out of line with our principles. It is wholly self-inflicted, and we deserve the criticism we've received. We will use the scar tissue from this painful mistake to help make better decisions going forward, ones that match our mission. With deep apology to our customers, Jeff Bezos
Founder & CEO
Amazon.com

As far as I'm concerned, that's that!