SADLY, the lull proved but brief. The first two weeks of the year were surprisingly calm for the storm-tossed euro zone. But a gale is blowing again. First a series of downgrades from Standard & Poor's, a leading debt-rating agency, coincided with a stand-off in the “voluntary” restructuring talks between Greece and its private bondholders. Now there are signs of a continent-wide recession. The euro crisis is back.

Indeed, the next few weeks could be decisive for the single currency's future. Several euro-zone governments must sell huge amounts of debt in bond auctions. They are also due to wrap up negotiations over the new “fiscal compact”, demanded by Chancellor Angela Merkel of Germany to enforce budget discipline, at a European Union summit at the end of January. And the brinkmanship in Greece's debt talks could yet lead to a disorderly default (see article).

What happens in Greece could be dramatic and painful, especially for the Greeks. If their country is forced out of the euro zone after a chaotic default it will cause problems for everyone. Yet Greece is small and its creditors see a restructuring as inevitable. The crucial country is Italy.

Italy is too big for the existing rescue fund to bail out. (Spain is at risk too, but its debt is a lot smaller and the markets are more confident it will be repaid.) Italy is unique in its combination of size and punishingly high bond yields (currently 6½%). It is hard to see the euro surviving were the world's third-biggest debtor judged unable to pay its creditors.

The immediate consequence of this for Mrs Merkel is that any sort of restructuring of Greece must therefore come with a credible plan to “backstop” Italy (and other weak countries), at least in the short term. Without such backing, the markets will simply move on, perhaps very quickly, from Greece to Italy, and the many banks that have lent to it. A credible firewall from the European Central Bank (and possibly the International Monetary Fund) would stop them.

But staving off contagion is not enough. Italy also needs lower interest rates on its bonds. Sadly, the country epitomises the economic and political problems in Mrs Merkel's strategy of relying on fiscal austerity to save the euro.

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In economic terms, Italy's main problem is not public profligacy. Its debt may be huge, but it is running a primary budget surplus (ie, before interest payments), its overall budget deficit is much smaller than France's, and its recent budget puts it on course to eliminate that deficit in 2013. Under a new government, led by Mario Monti, a former European commissioner, Italy has regained the place at the top European table that Silvio Berlusconi lost (see article). Mr Monti has not merely pushed through a tough budget, but he is also embarking on a difficult, if overdue, set of liberalising and structural reforms to open up sheltered parts of the economy to competition.

Grow—and carry the people with you

It is growth, or rather the lack of it, that is Italy's weakness. Within the euro, it has suffered a big loss of competitiveness as unit labour costs have shot up, largely because productivity has been stagnant or even fallen. And as elsewhere across the euro zone, austerity is not helping. Italy's public sector is trying to deleverage at the same time as the private sector is cutting spending, producing a nasty recession. The drive to cut budgets and debt as a proportion of GDP becomes ever harder as the denominator shrinks, especially if the answer from Mrs Merkel is always still more austerity. In contrast, America has largely avoided this trap by deferring its public-sector deleveraging into the future (see article).

Structural reforms are essential, but Italy also needs stronger demand. Mr Monti is not asking the Germans to embark on reflation, because he knows they will say no. But he is urging them to liberalise their own service industries, which should boost consumption. And he wants to see lower interest rates on Italy's debt, to pacify taxpayers facing bigger bills and special interests that will lose from more competition. This requires more support for bond markets by the European Central Bank or by an expanded bail-out fund.

If the economic arguments do not persuade Mrs Merkel, then the politics should. Mr Monti runs a “technocratic” government that lacks a single elected politician. For the moment, he has strong support both from Italian voters and from the main political parties (which naturally prefer to see him taking the blame for imposing austerity and structural reforms). But democratic consent for such harsh measures rests on being able to show Italians that they will ultimately benefit.

Mr Monti says resentment in Italy of Germany as a “ringleader of European intolerance” is already rising. For the euro a populist revolt in debtor countries would be the biggest threat of all. Mrs Merkel should remember that.