After Creating First Container, Module Insists Selecting Non-Existent Category

You most probably did the grave mistake of configuring your new container, so that it's mandatory to categorize posts of the type "Category" and "Container" under XYZ. That doesn't make much sense, and if ever containers and categories should be categorized by other categories, it should only be configured as mandatory after the whole structure is set up. Seems like you locked yourself in an infinite loop of mandatory-categorization requirements.

Playing with Taxonomy is not going to help, you only can make a mess by running Category and Taxonomy together. If Taxonomy is needed, then install the Taxonomy Wrapper from Category administrative pages.

Now how to delete the broken container? I'm unsure what happens in straight deletion attepmts, but you might be able to edit the container, and configure it so that the categorization is not mandatory (open the "Container settings" part, it's there, somewhere...). If that doesn't work, try to reach to the database (with PhpMyAdmin or similar) in the table "category_cont", and change the "required" field from 1 to 0 on your container (should be the only row there, I guess). As a last resort, it might be possible to disable Category module (assuming that you don't have any real data in Category yet, I guess that's going to change XYZ to a regular node of unknown type, possible to delete, but I didn't really try this). This is dangerous option though, so keep backup copy.

This is a support request, unless something is really broken in code. Also assigning to yourself means that you're willing to resolve the issue, so it doesn't really help to get help from others ;-)

Thinking further, you should most probably also flush cache (after changing the "required" field in database), by hitting the cache clearing button on Performance administrative page.