Of course they can be competitive with his contract. Fans and the media are ridiculous when it comes to fear of contracts. He's a great player and will take up cap space, duh. They just can't make dumb moves anymore. (ie Cassell for Jaric, Spree for nothing, although both of those are just bad luck really). Some shrewd GMing could get that team back to contender status in one year. (and making horizontal deals like the Wally World one do not count as shrewd GMing)
But if they trade away KG they're left with nothing. Their team is bottom of the league without him, not just out of the playoffs. So asking for a superstar is not unreasonable, otherwise their stuck with a bunch of "moveable pieces" on a 15 win team. Getting small contracts and servicable players only works if you have other players to build around (ie Kobe post-Shaq, Miller/Bibby/Peja post-Webber). Imagine if Webb got traded for the Philly 3 and the rest of our roster was Marcus Banks, Ricky Davis, Mark Blount and Rashad McCants. Not a pleasant thought. Add Kenny Thomas or Lamar Odom to that team and it still blows. So they really have no choice but to build with KG or get someone equivalent who can be a centerpiece, not a nice good complementary one (like Miller, Bonzi or whoever else we would offer other than Artest)