I have been much more positive about the Japanese economy than most other analysts in recent months, largely because I believed that many of the problems from the Japanese recession of 1990-2003 were finally in the country’s rearview mirror. In particular, I believed that the Japanese budget deficit – which, by 2003, had become quite acute – was well on the way to being solved through public spending restraint. That, in turn, would allow Japan to pay down its excessive public debt, giving its private sector room to expand.

But the surprise resignation of Japanese Prime Minister Yasuo Fukuda on Monday suggests I may have been wrong about the country’s near-term prospects.

Japan Gives Investors a Bubble Bath

The Japanese stock market and real estate bubble of the 1980s is now the stuff of stock-market legend, for it sent that country into a tailspin in 1990-91, after which came more than a decade of very slow growth.  There were a number of causes – one was the appalling quantity of rubbish loans that Japanese banks had put on their books during the bubble (sound familiar…. perhaps we are we seeing a reprise here in the U.S. market?), and the second was the inexorable expansion of the Japanese public sector.

Prime minister after prime minister would propose “stimulus packages” of public spending, mostly on roads and bridges in rural areas (always popular with politicians from those areas). The largest package – by Prime Minister Ryutaro Hashimoto in 1998  – was more than $400 billion, the equivalent of 10% of Japan’s gross domestic product (GDP).

Apart from covering Japan’s beautiful scenery with unsightly overpasses, these capital infusion packages had two very clear effects:

• They increased Japan’s public spending – from 31.5% of GDP in 1991 to 38.1% of GDP in 2002.
• And they created a huge public debt problem; Japan currently has public debt of 182% of GDP, the highest ratio in the world.

These stimulus packages had one very obvious shortcoming – they didn’t stimulate. And with good reason. These programs did nothing useful to revive the Japanese economy because the mostly useless public works projects they financed (in terms of GDP, these projects were more than twice as large as those of the next-most-profligate public-works spender – France) were using up all the domestic capital that should have been financing private-sector growth. In the parlance of economics, this is known as “crowding out,” and can be quite damaging, as Japan’s experience demonstrates.

Japan’s Prime Minister Troika

Since 2003, the key figure in Japan’s economic recovery is former Prime Minister Junichiro Koizumi (2001-06), who stopped building “bridges to nowhere” – prompting major protests from the Liberal Democratic Party (LDP) “old guard.” That stopped the growth in debt and then gradually brought the budget deficit down. As a result, Japan’s economic growth resumed in 2003.

Koizumi was succeeded briefly by Shinzo Abe, and then by Fukuda. Like Koizumi, Fukuda was a proponent of reducing public spending – he wanted to balance the Japanese budget by 2011. Indeed, Koizumi and Fukuda were actually quite close: Koizumi got his political start under the premiership of Fukuda’s father (also a tight-budget man) in the 1970s. So you can see why I was so confident that Japan’s public spending would be kept under control and that the Japanese economy would continue recovering.

Japan’s GDP showed a surprise dip in the second quarter, shrinking by 0.6%. As a result, public clamor arose for a “stimulus package” of public spending or tax cuts. The reality, however, is that Fukuda had been having a hard time since July 2007, because the upper house of the National Diet (which has considerable power) had been controlled by the opposition Democratic Party of Japan, blocking legislation.

Fukuda’s weakness was demonstrated by his Aug. 1 appointment of his political opponent, Taro Aso, as secretary general of the LDP. When Fukuda’s cautious Aug. 29 stimulus package of $18 billion – which consisted mostly of loans – was decried as inadequate, he realized that the clamor for extra spending would be unstoppable, and resigned.

Fukuda will likely be succeeded by Aso, a protégé of the big-spending barons of the rural constituencies.

Déjà vu all Over Again

The bottom line is that the public sector is likely to grow again, as it did in the 1990s, producing larger Japanese budget deficits, packing on more debt and stifling private sector development. Since Japan’s public debt is already so high, the chances are good that the country’s debt rating of AA (Standard & Poor’s) /Aa3 (Moody’s Investors Service (MCO)) will be downgraded. That would increase borrowing costs for all Japanese companies and damage the economy badly.

For more than a year, I had been positive on the Japanese economy, even as the market declined. But it’s finally time for a shift in outlook:

• In the near term – until the political situation can be sorted out – it’s better to underweight Japan in our portfolios.
• Long-term, however, we still believe that Japan is superbly positioned to capitalize on its proximity to China; indeed, as we’ve noted, the two countries are quietly forming what may one day well be the most powerful trading alliance on the planet.

In the meantime, until it becomes clear that this China-Japan connection can pump up the Japanese economy, there’s another Asian market – actually, one of the “Four Asian Tigers” – that’s clearly worth a look as an alternative.

And that market is Korea.

Korea’s Profit Promise

The Korean government recently improved with the election of president Lee Myung-bak and a pro-business party with a substantial majority. Korea’s economic growth is likely to accelerate, particularly if we have seen the worst of the commodity and energy bubble, since Korea is primarily an importer of commodities and energy goods.

The Korean stock market has been beaten down this year, dropping 20%, and currently trades at only 10 times earnings. But this low valuation is undeserved, since the Korean economy is expected to grow at better than a 4% clip for both this year and next, according to the respected global-economics magazine, The Economist.

Take a look, for example, at the Korean exchange-traded index fund (ETF), the iShares MSCI South Korea Index Fund (EWY), which tracks the Morgan Stanley Capital International Korea index. The ETF currently carries a Price/Earnings (P/E) ratio of 10.3 and features a dividend yield – after expenses – of about 1.9%.

[Editor’s Note: For additional insights on Korea, check out Money Morning’s investment research report: Why South Korea is set to Become the Biggest Economic Story of 2008. The report is free of charge. For broader investment insights on Asia in general, check out our research report on the once-in-a-lifetime profit plays being created by China’s emergence – and find out how you can get a free copy of investing guru Jim Rogers’ bestseller, “A Bull in China.” Money Morning recently ran a two-part story (Part I and Part II) detailing our most recent exclusive interview with the global-investing guru.]

News and Related Story Links:

• Wikipedia
  : Yasuo Fukuda.

• Money Morning Economic Analysis:
  
  The Lost Decade: How the U.S. Financial Crisis Resembles Japan’s Ten Years of Misery – And How to Play it (Part I of II).

• Money Morning Economic Analysis:
  
  The Lost Decade: How the U.S. Financial Crisis Resembles Japan’s Ten Years of Misery – And How to Play it for Profit (Part II of II).

• Wikipedia:
  
  Ryutaro Hashimoto.

• Money Morning Economic Analysis:
  Two Ways to Profit as China and Japan Quietly Forge the Most Powerful Trading Alliance in the World.

• Wikipedia:
  
  Crowding Out.

• Wikipedia:
  
  Junichiro Koizumi.

• Wikipedia:
  Shinzo Abe.

• Money Morning News Analysis:
  
  Japan Plans Stimulus, but Economy Still Likely to Fall into Recession.

• Wikipedia:
  
  Japanese National Diet.

• Wikipedia:
  
  Democratic Party of Japan.

• Wikipedia:
  Lee Myung-bak.

• Money Morning Foreign Market Analysis:
  
  Six Ways to Capitalize on Korea’s Growing Global Muscle.

• Money Morning (Free) Investment Research Report:
  Why South Korea is set to Become the Biggest Economic Story of 2008.

• Wikipedia:
  
  Four Asian Tigers.

• Money Morning Exclusive Jim Rogers Interview From Vancouver (Part I):
  Exclusive Interview: Jim Rogers Predicts Bigger Financial Shocks Loom, Fueling a Malaise That May Last for Years.

• Money Morning Exclusive Jim Rogers Interview From Vancouver (Part II):
  Exclusive Interview: Jim Rogers Continues to View China as the World’s Best Long-Term Profit Play.

Cleveland-Cliffs Inc. (CLF), a top producer of iron ore pellets and supplier of metallurgical coal in North America, will buy Alpha Natural Resources Inc. (ANR) in an effort to bolster its coal reserves and exploit the soaring demand for steel among emerging markets worldwide.

Cleveland-Cliffs is paying $10 billion for Alpha Natural Resources, a company that specializes in mining thermal coal used in steel production, the company said on its website. The deal values Alpha at $128.12 per share, a 35% premium to its closing share price on Tuesday.

Alpha shareholders will receive 0.95 Cleveland-Cliffs shares and $22.23 in cash for each share they hold. Alpha shareholders will hold 40% of the resultant company.

"By combining our companies’ complementary operations and management capabilities, we will be well positioned to meet the world’s increasing demand for raw materials," Joseph Carrabba, Cleveland-Cliffs’ chairman and chief executive officer, said in a statement.

The new company, which will be known as Cliffs Natural Resources, will operate nine iron ore facilities and more than 60 coal mines throughout North America, South America, and Australia. The company’s iron-ore reserves will total one billion tons, while its coal reserves will more than triple to 916 million tons. The annual savings from cost synergies will be at least $200 million by 2010.

Cleveland-Cliffs brought in $2.28 billion in revenue last year, while Alpha took in $1.64 billion. Together, the companies expect to see total revenue of $10 billion by 2009.

"This transaction is a good strategic fit for Cleveland-Cliffs as it gives them a stronger presence in the very tight metallurgical coal market and complements their iron-ore business," Brian Hicks, co-manager of the $2 billion Global Resources Fund at U.S. Global Investors Inc. (GROW) told Bloomberg News.

Coal and iron ore are the two key ingredients in the production of steel, which is in high demand throughout the developing world.

"Global steel demand growth continues to be led by emerging economies to meet the requirements of expanding industrial sectors and infrastructure growth," Risaburo Nezu, chairman of the Organization for Economic Cooperation and Development (OECD) steel committee, told Forbes. "Demand in many mature economies has slowed in line with weaker economic activity."
According to Nezu, steel use continues to grow most rapidly in the so-called "BRIC" economies of Brazil, Russia, India, and China. In 2007, steel use rose:

• 18.6% in Brazil
• 13.5% in Russia
• 11.3% in India
• 13% in China

All told, those four countries found uses for 521 metric tons of steel, with China accounting for 78% of that total.

While the price of U.S. steel-sheet hit a record $1,052 a ton in June, rising from $532 a year earlier, the price of coking coal and iron ore have doubled in the past year as well. As a producer of both products Cliffs Natural Resources will be well positioned to exploit emerging market growth.

News and Related Story Links:

• Cleveland Cliffs Inc.:
  Cleveland-Cliffs and Alpha Natural Resources to Merge, Creating Cliffs Natural Resources, a Leading Diversified Mining and Natural Resources Company

• Bloomberg:
  Cleveland-Cliffs to Buy Alpha as Coal Prices Surge

• Money Morning:
  Merrill Lynch: Emerging Market Infrastructure Spending Will Surge 80% in the Next Three Years

• Money Morning:
  Cashing in on Commodities: Gold May Glitter, But Heavy Metals Shine

In a move that surprised investors, Anheuser-Busch Companies Inc.’s (BUD) board voted to end more than 150 years as a family-controlled company, accepting a $70-per-share bid from Belgium’s InBev NV in a deal that puts a $52 billion price tag on the iconic American brewer.

The St. Louis-based Anheuser-Busch – which had appeared to be digging in for a long battle – and InBev approved the all-cash deal, according to a joint statement released yesterday (Monday).

Anheuser-Busch’s popular Budweiser and Bud Light beers will join an InBev stable that includes such well-known brands as Stella Artois, Beck’s, and Brahma. The resultant merger will produce the largest beermaker by volume, supplanting the current title-holder, Britain’s SAB Miller PLC (OTC: SBMRY).

"Together, Anheuser-Busch and InBev will be able to accomplish much more than each can on its own," InBev Chief Executive Officer Carlos Brito, who will helm the new company, said in a joint statement. "We have been successful business partners for quite some time, and this is the natural next step for us in an increasingly competitive global environment."

The takeover battle had been shaping up in both the boardroom and the courtroom since InBev launched its original $46 billion offer for Anheuser-Busch back in May. Fierce opposition from the board, led by Chief Executive Officer August Busch IV, was finally overcome by InBev’s bid increase of 7.7% and the Belgian brewer’s agreement to name the newly formed global entity Anheuser-Busch InBev.

"This is about giving InBev a U.S. presence and this is the most effective way they can see to achieve that," Grant Saligari, a beverage industry analyst at Commonwealth Securities Ltd. in Sydney, told Bloomberg News. "Consumers are very emotionally attached to their beers. A peaceful deal helps maintain that."

The Mexican Stumbling Block?

While Anheuser-Busch and InBev management might all be in agreement, there are still a few snags that could derail the deal. First, Anheuser-Busch shareholders have to approve the deal. That vote will probably come in about two to three months time. 

And while it’s unlikely to derail the planned merger, the U.S. Congress could get involved if there is an antitrust angle, or if a particularly "patriotic" senator, such as Senator Claire McCaskill (D-MO), has reservations about selling the 150-year-old American giant to foreign investors.

However, the biggest hurdle could come from Grupo Modelo SA de CV (OTC: GPMCF), the Mexico-based maker of Corona beer that is half-owned by Anheuser-Busch. 

In a statement released during yesterday’s early morning hours, Modelo asserted that it "has certain rights with respect to the potential transaction between InBev and Anheuser-Busch, including a consent right," The New York Times reported.

Modelo is referring to its right of first refusal if its shares, 50% of which are owned by Anheuser-Busch, are sold. There also is a provision in Modelo’s contract with Anheuser-Busch that restricts the American brewer from selling Modelo’s shares to a competitor – which InBev clearly is.

Modelo is currently in talks with InBev and most analysts feel the Mexican and Belgian brewers will be able to come to an amicable agreement.

"If I had to make a prediction, I would guess that after a relatively short period of time [Modelo is] going to accept the new status quo, which in some ways is the old status quo," Steve Dixon, manager of Global Beverage Fund at Arnhold & S. Bleichroeder Advisers LLC in New York, told Reuters.

Aneheuser-Busch and InBev Merger Just One of Many

This merger is the latest in a string of consolidations in the largely mature global beverage industry, as skyrocketing grain costs and softening economies have led struggling brewers to seek economies of scale. Two of the largest brewers, InBev and SAB Miller, are themselves creations of mergers that took place within the past 10 years, The New York Times reported.

In January, Carlsberg A/S and Heineken N.V. (HINKY) agreed to buy Scottish & Newcastle PLC for $15.4 billion. Late last year, British-owned SAB Miller PLC (OTC: SBMRY) and Canada’s Molson Coors Brewing Co. (TAP), agreed to merge their U.S. brewing operations.

Once InBev acquires Anheuser-Busch, it will leave The Boston Beer Co. Inc. (SAM), maker of the popular Samuel Adams beer brand, one of the last large domestic brewers still under U.S. ownership.

News and Related Story Links:

• The New York Times:
  Anheuser-Busch Agrees to Be Sold for $52 Billion

• The New York Times:
  Cracking Open the Anheuser Deal

• Bloomberg News:
  InBev Agrees to Buy Anheuser-Busch for $52 Billion

• Reuters:
  Mexico’s Modelo should warm to new partner InBev

• Money Morning:
  InBev Offers Anheuser $46.3 Billion, a Deal That Would the Create World’s Largest Brewer

• Money Morning:
  Global Beer Titan InBev to Make $46 Billion Offer for No. 1 U.S. Brewer, Anheuser-Busch

Minutes after the Dept. of Justice approved Sirius Satellite Radio Inc.’s (SIRI) merger with XM Satellite Radio Holdings Inc. (XMSR), each company’s shares soared by double-digits…

Yet, until the merger is completed, it’s hard to know whether that sharp jump will continue… whether now is a time to jump in with both feet… or whether the surge will cool on the heels of valuations soon-to-be posted by analysts, who no doubt are bleary-eyed and caffeine-drunk from crunching the numbers through the night.

So the question is, should you buy?

The answer is not an easy one. It depends on three factors.

To begin with, the merger – which was first proposed in November 2007 – still has to pass through the Federal Communications Commission, which could impose conditions that alter the agreement and/or favor the groups that lobbied heavily against it.

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The FCC is expected to rule within the next few weeks. April Horace, an analyst with Janco Partners who has been following Sirius, said the FCC shouldn’t take too long to ponder.

"It’s not like this hasn’t been sitting on the FCC’s plate. It’s been there for a year," Horace said.  

In its ruling, the Dept. of Justice said that a Sirius/XM merger would not violate anti-trust laws because the satellite radio providers face competition from AM and FM broadcasters, television, mobile phones and online music stores and radio stations.

Secondly, the merger still faces tough opposition from one of the most powerful lobbies in the world. Many of Sirius and XM’s competitors are part of the National Association of Broadcasters, one of the merger’s most prominent opponents. And looking at its executive committee – which includes senior managers from billion-dollar media titans such as Hearst-Argyle Television Inc. (HTV), Gannett Co. Inc. (GCI) and Belo Corp. (BLC) – it’s no wonder the DOJ investigation took so long. 

"We are astonished that the Justice Department would propose granting a monopoly to two companies that systematically broke FCC rules for more than a decade. To hinge approval of this monopoly on XM and Sirius’s refusal to deliver on a promise of interoperable radios is nothing short of breathtaking," The National Association of Broadcasters said in a statement.

Third, will this merger give the combined companies the leverage they need to reduce operating costs and increase profit?

The merger would likely combine XM and Sirius’ content together for a lower price. Subscribers of both now pay $12.95 a month, but may pay as little as $6.99 with the proposed tiered pricing, Bloomberg reported.  

Sirius has 7.67 million subscribers who have access to premium content that includes talent such as Howard Stern and NASCAR broadcasts. While XM’s 8.57 million listeners pay a premium for content from Oprah Winfrey, Major League Baseball and in-studio artist performances.

To fund such content and compete with each other, both Sirius and XM spend [and lose] hundreds of millions of dollars a year.

Together, they can combine their best programming and management and form a music and news medium better equipped to fight against billion-dollar competitors such as Clear Channel Communications, Inc. (CCU) and Apple Inc. (APPL).

Should you buy?

The cons outweigh the pros, said Lou Basenese, an M&A expert and editor of investment newsletters The Hot IPO Trader and The Takeover Trader.

"Don’t buy either stock, even if they finally get FCC clearance. Ultimately, share prices follow earnings. And neither of these companies have any. Combining won’t change that fact," said Basenese, who has been following the Sirius/XM merger from the beginning.

Moreover, while the premium content of each satellite radio provider is worth its suggested new price, a merger would combine the debts each station paid to have the likes of Howard and Oprah.

"Both companies overspent to acquire content in a bid to expand subscribership as fast as possible – a fatal mistake that will make sustained profitability (as independent or combined companies) impossible for years to come," Basenese said. 

XM shares closed at $13.79 yesterday, going up $1.85 for a 15.49% gain. Sirius shares closed at $3.15, up $0.25 for an 8.62% gain.

Shareholders already approved of the merger. More than 96% of those who voted approved the transaction in separate meetings in November, Bloomberg reported.

But again, a large part of the final deal depends on what stipulations, if any, the FCC lays forth.

News and Related Story Links:

• Wall Street Journal:
  Sirius-XM Gets Antitrust Approval

• National Association of Broadcasting:
  NAB Statement on Today’s DOJ Decision Regarding XM and Sirius

• Bloomberg:
  XM Satellite, Sirius Combination Approved at Justice