The SM mics ARE cheap mics. However I agree that they are great mics used for countless famous records. I know Red Hot Chili Peppers swears by them both in studio and live.
The basics you need are:
I know Reaper is dirt cheap, and a much better DAW than many more pricey options. If you plan to do lots of MIDI, Reaper has the best sounding piano/drums but you can't record audio in unless you get Reaper Record, which is a great DAW. IMO Ableton's MIDI instruments suck and are only good for live music or hiphop/electro/etc.
Keep in mind that your first microphone is like your first girlfriend: it's not important. Besides, a cheap one like a Shure SM57 or Sennheiser e609 can produce amazing results if you know what you're doing. If you plan to do acoustic instruments, look into a condenser (I personally can't recommend any).
As for monitors, the KRK RP8 are great for beat-style music with heavy bass. If you want something with a little tighter low end, the M-Audio BX5a are great as well (I use them).
As for audio interface, PreSonus makes a great budget model, the FireStudio Mobile I think? It has really good pre-amps for the price. I use an M-Audio Fastrack Pro because I got it for next to nothing, and while it gets the job done for me, its preamps are horrid and produce a weak, noisy signal.
Despite what many will say, you can get AMAZING sound with the aforementioned setup as long as you know what you're doing. The quip that "equipment is only as good as the user" is especially true when it comes to audio recording.
If you want to know more, I suggest you spend some time reading up on www.tweakheadz.com