The reply coupon that
gave its name to a fraud
On 12 August 1920, Charles Ponzi was arrested in Boston. In a few months this Italian immigrant had drawn in savers by promising a 50% profit in forty-five days, thanks to a post-office trick: buying international reply coupons.
A real arbitrage, an impossible promise
The international reply coupon let a sender prepay the return postage on a letter abroad: bought in one country, it could be exchanged in another for stamps. In the wake of the First World War, inflation and the fall of several European currencies, the Italian lira in particular, made these coupons very cheap compared with the American stamps they entitled the holder to receive. In theory the gap offered a profit. Ponzi made it the pitch of a company, the Securities Exchange Company, set up in Boston in early 1920.
He promised 50% in forty-five days, or 100% in ninety. The first subscribers were paid as announced, sometimes with the money of those who followed; word of mouth did the rest, and by the summer of 1920, by some estimates, hundreds of thousands of dollars were pouring in every day.
On 26 July 1920 the Boston Post published the decisive calculation: to cover the sums invested, some 160 million reply coupons would have been needed, when only about 27,000 were in circulation. The arbitrage existed, but it had never been able to absorb such volumes. Earlier investors' interest was being paid out of newer investors' deposits.
Ponzi was arrested on 12 August, charged with mail fraud, and served several years in federal prison.
A small arbitrage does not make a large return
The case became so emblematic that "Ponzi scheme" now names any arrangement that pays earlier investors with the payments of later ones, of which the Madoff affair, in 2008, was the most resounding example. What strikes one is that the starting point was partly true. An arbitrage did exist. But a price gap pays only on the volumes the market can absorb: a real but narrow strategy, presented as extensible without limit, stops being a strategy and becomes a lie.
Hence the three questions 1920 invites us to ask: where does the return come from? What is its maximum capacity? Who pays the interest? A high, steady return with no identifiable source and no ceiling on volume calls for verification before trust.
A promise of return that cannot say where it comes from already says where it is going.