Too Much Employment "Works Up" A Bad Economy?

On a gut level, the idea of high unemployment brings feelings of despair and insecurity to workers and economists. So one might assume that extremely low unemployment would be intrinsically good. Not so, says Joel Naroff. If the unemployment rate dropped to 3.5%, as analyst Ed Yardeni predicts, Naroff says the negative effects could spread from big business to the Fed to interest rates. The two sparred briefly over the issue today on "Morning Call."

Yardeni is president of his own research company, and he says there's a real possibility that the unemployment rate could sink to 3.5% over the next 12 months. He credits the growing economy, which was strong even in Q4 last year. As employers realize that 2007 is going to be strong, there will be a "hiring panic," he says.

"I think they're going to scramble to get anybody they can because they need people to expand [as the economy grows]," Yardeni says.

But Naroff says that even if Yardeni's right, the drop in rate will only register a few tenths of a point. Wages are two-thirds to three-quarters of a business' expenses, and they're growing faster than they have in a long time. But what's been driving spending, expansion and cash flow in business--has been companies' ability to keep labor costs under control. (In other words--more workers means higher wages and associated labor costs).

"This is a potential hit to their bottom lines and to their ability to invest in capital expenditures," Naroff says.

As CNBC's Michelle Caruso-Cabrera pointed out, the increasing wages lead to Fed worries about inflation, and that can cause an increase in interest rates.

Yardeni insists that worker productivity will balance out any potential for inflation. Maybe so, says Naroff, but the pressure on wages will ripple through to corporate earnings.

The last time the U.S. saw unemployment of 3.5% was in 1969. Both analysts agreed that conditions have changed dramatically since then, so the factors at play then are irrelevant in today's market.