A solution to the restore problem
I've been having the same problem. I tried to update my iPhone G3 to operating system 2.01, it failed, and told me I had to do a restore. All attempts at the restore failed, even after trying many, many hints on-line. I have a PC with an XP operating system. It is about 5+ years old. My solution was, finally, to go to my wife's newer system (less than a year old, with a Vista operating system), load iTunes latest version, and then plug in my iPhone. At first it didn't recognize the iPhone, but then after doing the "hold down the power and that other key" trick, it finally recoginized it and again told me that I needed to do a restore. I did the restore, and viola, it worked!!! One thing, it did a restore to V2.01, the latest operating system, something my older computer never tried. After the successful restore I took the iPhone back to my older computer (it still had all my backup stuff from my old iPhone), and did a synch with my old data. It asked me if I wanted to erase the information from the new computer, and I said "Yes", and it then resysnched all of my old data. Apparently my old computer had the wrong USB (older system) or didn't have the more up-to-date driver needed to accept the iPhone. Anyway, it works now!! Now if I could only get it to send email using charter.net...
Good luck to all, Steveo