Are We In An Economic Recovery Yet?: Analyzing The "Green Shoots" Debate

Are the first signs of leaves sprouting from the money trees of the big banks, or is the soil still not fertile enough? That’s the hottest debate in the financial sector right now, where investors are wondering if the worst is over and, more specifically, if an economic recovery is underway now.

Dubbed the “green shoots” debate, there are compelling arguments on both sides. But here’s the problem: both sides may be right.

Proponents of the green shoots argument — which is a term for economic recovery — argue that while the going is still tough, the worst is over.  Banks such as Citigroup, Goldman Sachs and Deutsche Bank all reported profitable first quarter earnings results, after all.

Recapitalization is coming back as the stock market shows signs of strengthening, and while the U.S. economy is still in recession, there are significant signs that the rate of contraction is slowing. Even Federal Reserve chairman Ben Bernanke has made noises about an economic recovery led by a healthier banking sector.

Then again, April retail sales came in much lower than expected, while credit conditions are far from safe. Most damningly perhaps, ratings agency S&P announced Wednesday that the U.S. banking crisis may last until 2013, having “merely entered a new phase” recently.

“There’s nothing to say that this banking crisis can’t go on for another three or four years,” S&P managing director Tanya Azarchs told Reuters.

The Atlantic’s Megan McArdle agrees. She argues that just as for the beginning of the 19th century, the long fight out of this credit mess may eventually wear us down:

I don’t want to push the Great Depression analogy too far, but what’s surprising when you go back to primary sources from 1930 is the optimism … [But] it was the long grind of the years that followed, and the catastrophe of the second banking crisis, that scarred them permanently.  And this shows up in the economics stats and the stock market, which did not, as we like to imagine, simply decline in a straight line.

On the other side of the argument, economist Steven Levitt argues in an excellent three-part series in the New York Times that the situation we are in today is nothing like that of the Great Depression. That’s probably right. For a start, we haven’t yet experienced four consecutive quarters of GDP decline, which is the traditional economic definition of a depression. Secondly, economic conditions today are entirely different from those in the 1930’s.

In today’s highly globalized economy, there’s adequate liquidity elsewhere in the world to oil the wheels of the banks when things go wrong. For example, Asian financial institutions have been a big help in bolstering the balance sheets of U.S. banks lately, which has sped the recovery up a bit.

Then again, financial infrastructure is still weak and consumption is hardly impressive. Families are still being hit on a personal level by a lack of available credit.

In other words, we probably are seeing signs of a recovery, but that may be all that it is. If the recovery is taken by banks as a signal to start lending aggressively to one another too soon, that might cause bigger problems than we started out with, because the infrastructure of the financial landscape isn’t strong enough to support that yet.

The real danger is that we grow a full-blown apple tree in the desert, and then discover the water we thought was under it was in fact, just a mirage.