In 1982, real 10-year Treasury note and T-bill yields peaked near 9.2% and 7.2%, respectively (Figure 3). Nominal yields near 16% for notes and 19% for bills were the highest yields ever (Figure 4). Back then, inflation stayed above 6% from March 1977 through June 1982. Notes and bills peaked near 16% and 20%. It is no wonder that investors were obsessed with inflation hedges, hated bonds and were indifferent to stocks.

The Yale model still holds a bias for bonds that stems from the ravages experienced by bond investors in the 1980s. What Yale failed to account for was that after an excessive level of private debt, Treasuries are the supreme diversification asset. Yale declined to balance its assets to hedge inflation risk and deflation risk. It had the evidence and the time to do so, because given our circumstance since 2003, students of history knew that inflation risk would not override default risk until a large portion of private debts (at risk of default) became the liabilities of the U.S. government. This realization would have helped Yale to protect assets better in 2008.

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