When reports came out last week that Google and Yahoo were downsizing their controversial search advertising deal, I told a Yahoo exec I happened to be having dinner with that that it was the surest sign that the search giant was about to dump the long-suffering Internet portal.

The exec, who made the case that the deal was always tactical, and not strategic, laughed. For all its problems, Yahoo (YHOO) has always been a straight-up player and such sneaky machinations are not its strong suit.

Google, not so much.

After all, Google (GOOG) had already tried using The Wall Street Journal the week before to try out an our-way-or-the-highway tactic to play chicken with the Justice Department, to no avail.

As I wrote:

And, while it might be testing the Justice Department in hopes of salvaging the deal, I suspect Google–as much as its founders want to help out Yahoo CEO Jerry Yang and block Microsoft at the same time–is just now figuring out that walking might actually be the best move.”

Then in a sudden switcheroo just days later, Google was doing the docile-dog play, using the Journal again to signal that it was willing to compromise drastically to do a deal and trying more to look cooperative with the Justice Department.

Now, Google is not some Internet Sybil–way out of the deal one week and in another. Instead, it was creating what one might call “plausible deniability,” a Washington, D.C. term that essentially means covering your own petard.

Despite Google’s last-minute theatrics of cooperation, I am sure the decision had long been made at its California Googleplex lair that it would bow out.

After all, many top execs at the company were dead set against it from the start, mostly due to the undue scrutiny it would bring to Google. Those execs now had plenty of ammo to mercilessly strafe the deal from behind.

Early on, that was also a big worry of Google’s own operatives in D.C., who expressed concern–largely ignored at HQ, where execs really do see themselves as not even slightly evil–about its growing image as a scary behemoth.

Well, that picture is now most definitely solidified in the minds of regulators, helped along by the dangerous pontificating by CEO Eric Schmidt a little while back, who haughtily declared that Google would move forward with or without government approval.

“Time is money in our business,” said Schmidt, in a quote that I am sure he would like to take back now.

It was just the arrogant kind of attitude that Microsoft (MSFT) lobbyists, who have been hitting this deal hard like an old bass drum, needed in order to paint an ugly picture of Google in D.C.

And–more troublesome for Google–it gave advertisers and publishers, many of whom have long harbored fear of the company’s growing power, the courage to speak out, which they did in droves, along with many public interest groups.

But, as has been clear for a while, the Justice Department–after making its own big and noisy deal in its veiled public leaks of outside litigators and such–had to move forward with a lawsuit, and before the election was over.

And, indeed, as I have long maintained, stopping the deal was the right move all along, because a partnership between the No. 1 and No. 2 players just never should be allowed, however slight in its configuration.

As I wrote in April:

So, any further hook-up between the two seems sure to become the Justice Department Lawyer Employment Act of 2008, the likes of which we have not seen since Microsoft got its turn at being deservedly whacked for being a monopolist back in the last century.

Let’s face it, outside of those who cannot seem to shake the annoying Kumbaya mentality over at Google, a Yahoo-Google partnership is simply fantastical, like some out-of-control Dr. Seuss ditty.

They could not, would not with a goat. They would not, could not on a boat. They will not share an algorithm, they will not, will not, Jerry-I-Am.”

Because, although Google has almost none of the obvious menacing aggression that characterized Microsoft when it thoroughly dominated tech, the government was never going to allow such a clearly dominant company in search to strike such a deal, given the obvious antitrust implications.

As I also said then: “It is bad for advertisers, it is bad for consumers, it is bad for innovation, no matter how well-intentioned Google is.”

Thus, the die was cast for the inevitable dumping of Yahoo, in a hasta-la-vista-baby letter this morning terminating the partnership, which Yahoo should have seen coming many miles away.

Sources close to the company, which has been justifiably irked about how Google has handled itself with the Justice Department, said execs at Yahoo might have expected the move, but were deeply disappointed too.

(Here is Yahoo President Sue Decker’s memo on the collapse of the partnership.)

At least the very least, Yahoo did use the deal to escape the clutches of Microsoft in the midst of an ugly takeover battle, which investors now wish it had not, given its stock price is now half of what it was then.

And, indeed, it was perfectly tactical in that regard, using the software giant’s archrival, Google, to poke Microsoft relentlessly.

But Google would only prod so much, until it adversely impacted its own main goal of quiet but inevitable domination over search and, in fact, all online advertising.

When it did just that, dragging Google into a thorny briar patch, the company inevitably resorted to one of its internal mantras, “Feed the winners, starve the losers.”

Time will tell just how much a loser Yahoo will be from this latest bump in its current pothole-filled journey.

As to the candy-colored Google image? Well, it’s definitely not as sweet as it used to be.

Please see this disclosure related to me and Google.

Here is the entire interview Eric Schmidt did with Walt Mossberg on May 31 at D5 in Carlsbad, Calif. The Google CEO’s appearance is also posted here on YouTube (big surprise!) by Google.

The talk focused a lot on copyright, since Schmidt went on right after my interview with Philippe Dauman (that post has both text and video highlights). The CEO of Viacom, which is now suing Google for $1 billion for copyright violations, was very articulate about his problems with the search giant.

Still, Schmidt conceded no ground on the controversial issue, as you will see. But a lot of other things were discussed, including the future of search and online advertising, Google’s recent acquisition of DoubleClick and the fears over the growing power (and potentially evil behavior) of the Internet giant.

Here’s the video, which is a little over 50 minutes long:

Please see this disclosure related to me and Google.