Return of king dollar a sign of a stronger America?

Maybe the U.S. economy, a weakling for the last six years, is finally starting to flex some muscle. We're referring to the return of king dollar.

For those who haven't been paying attention, the greenback is in the midst of a rally not seen since the 1990s. It's racing past the euro, the yen and other currencies. Investors worldwide are buying the equivalent of stock in America Inc.

If the rise in the dollar's valuation is sustainable, it's welcome news for the stock market, for fighting inflation, and for U.S. growth prospects. Ronald Reagan said it best: A strong dollar is a sign of a strong America.



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This has been a long time coming. And it's still too early to tell whether the trend will continue. But the dollar has rallied significantly in recent months. According to The Wall Street Journal, "the resurgent dollar has logged its longest winning streak in 17 years, rising against a broad basket of currencies for nine straight weeks."

One immediate impact of dollar strength is that it increases the demand for U.S. stocks and bonds. But the dollar rally is also a restraint against inflation, as well as a market signal of U.S. competitiveness relative to rival nations. It's a hopeful sign that Janet Yellen and the Fed may be more effective inflation hawks in deedsthough not in rhetoricthan commonly expected.

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QE ends next month. And the Fed is expected to raise its target interest rate in 2015 and beyond. In any case, most of the Fed's balance-sheet expansion went into excess bank reserves instead of circulating throughout the economy. In other words, Fed policy was never as loose as people feared.

Naturally, some will write off the bull market for dollars as merely a sign that the greenback is the least rotten apple in the barrel. But that's not giving the dollar its due. It has been gaining strength against gold, which is the best measure of dollar value. At just above $1,200, gold has fallen back to early-January levels. And remember, gold peaked around $1,900 in mid-2011.

We think one key explanation for dollar strength is the amazing efficiency revolution in American business that's taken place over the last five years. U.S. companies have become the best run in the world as they've ruthlessly cut costs.

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Credit also the drilling bonanza in oil and gas, which is driving down energy costs for American producers of everything from steel to auto parts to microchips to chemicals to corn.

King dollar also is a capital magnet. We're already seeing this as foreigners flock to U.S. assets. The historical relationship is unmistakable. Periods of sustained economic growth and rising living standards are associated with a strong dollar. That was clearly true in the prosperous 1960s, 1980s, and 1990s.

And while the strong dollar restrains commodity prices, it acts as a tax cut for American consumers and businesses. Gasoline, for example, is down to $3.35 from nearly $4. The CPI is up only 1.7 percent over the past 12 months.

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A strong dollar increases the purchasing power of the greenback. So the money in your wallets and purses buys more goods and services.

Conversely, when the dollar crashed in the 1970sespecially relative to goldthe economy collapsed into a crippling stagflation. From 1999 to 2009, the dollar index dropped by almost 40 percent, with only a brief surge between 2004 and 2006. The economy and wages were sluggish at best.

The relationship between a strong currency and prosperity is lost on the many nations that adhere to the mercantilist model whereby a devalued currency supposedly gives a country a competitive edge by making exports cheaper. Japan is the classic example of this failed paradigm. Its economy has crashed in recent months thanks to higher taxes and a yen intentionally weakened to boost exports. The Japanese seem to think that the way to grow the economy is to make their citizens poorer.

Of course, numerous policy blundersObamacare, high corporate taxes, carbon regulations, Dodd-Frankare restraining U.S. growth and could derail the dollar comeback. But the rising dollar may be sniffing out new pro-growth policies in a Republican sweep come November.

In fact, the best growth combination would be slashing corporate tax rates to 20 percent, letting S-corp small businesses pay the lower C-corp rate, and ending the double tax on profits earned overseas. Then the Fed could start normalizing interest rates.

This approach would get the economy cooking again, without inflation. American workers would finally get real pay raises, while business investment and the stock market boom.

King dollar is the ticket.

Larry Kudlow is CNBC's Senior Contributor. Stephen Moore is chief economist at the Heritage Foundation.

Commentary by Larry Kudlow, a senior contributor at CNBC and economics editor of the National Review. Follow him on Twitter @Larry_Kudlow.