As others indicated, this error happens when there is a version mismatch between the mysql client software, and the MySQL Database server version. To date I've only encountered this problem when the server is Newer than the client. I'd suggest upgrading the client - as new versions of MySQL tend to accumulate useful features, but downgrading the server as suggested above should work. You can also start the server in old passwords mode -- but really just upgrade the client if you can.

Here are mysql.com's docs on the problem.