The Italian who ‘discovered’ money, but died a pauper

MUMBAI: “Just after four o’ clock, Ponzi wandered outside to buy the afternoon papers, generously tipping the first newsboy he came across. As he did, someone in the crowd yelled, “You’re the greatest Italian in history!”

“No,” Ponzi answered with a laugh. “I am the third greatest. Christopher Columbus discovered America and Marconi discovered the wireless.” The fan cried out, “You discovered money!”

These lines from Mitchell Zuckoff’s book, Ponzi’s Scheme, The True Story of a Financial Legend, point to the popularity Charles Ponzi, an Italian immigrant into the United States.

On November 3, 1903, Carlo Pietro Giovanni Guglielmo Tebaldo Ponzi boarded the S S Vancouver, bound for Boston. He survived doing odd jobs around in the US and Canada, was jailed a couple of times and changed his name to a more American sounding Charles.

After a series of jobs, Ponzi started “Charles Ponzi, export and import” with the plan of working as a commission agent for companies who were hoping to do some international trading. But there was a slight problem - Ponzi did not have any contacts.

“To attract business, Ponzi thought about printing circulars and sending blanket mailings to potential clients. But that would cost him a nickel per circular for domestic companies and eight cents each for international firms. Ponzi realised he would be wiped out by mailing fees before he collected his first commission. Instead, he decided to advertise in foreign trade magazines, but again he was stymied by the cost,” writes Zuckoff.

“That led to a new plan: He would start his own foreign trade publication, one whose huge circulation would allow him to charge lower advertising rates for budding entrepreneurs like him. Inspired, he had a new sign painted on his door - The Bostonian Advertising and Publishing Company - and set out launching a publication called the Trader’s Guide.”

Ponzi planned to mail 100,000 free copies to company whose names he found in the US Bureau of Foreign and Domestic Commerce and the US Consular Service. The plan was to keep doubling circulation every six months.

As Zuckoff writes, “The initial mailing, he thought, would cost him thirty-five cents a copy, or $35,000. To meet that cost, he would lard a two-hundred page guide with 150 pages of advertising. The ads would cost $500 a page, with a premium of $5,000 for the cover page, for a total imagined advertising income of $80,000. After expenses, he figured out a profit of at least $15,000 in the first six months. He expected his profits would double as many times as he doubled circulation.”

But, things did not work as planned. And then serendipity struck. In August 1919, he got a letter from a gentleman in Spain inquiring about the Trader’s Guide. “To pay the postage, the Spaniard had pinned to the corner of his letter a strange piece of paper,” writes Zuckoff. It was an international reply coupon, which could be exchanged for American stamps. The innocuous financial instrument gave Ponzi an idea.

As Zuckoff writes, “The coupon had cost the Spaniard thirty centavos, or roughly six cents. After a penny towards processing fees, it could be exchanged in the United States for a stamp worth five cents. Using exchange rates published in Boston newspapers, Ponzi concluded that a dollar was worth six and two-thirds pesetas. Because there were one hundred centavos to a peseta, Ponzi calculated that a dollar was worth 666 centavos. If each International Reply Coupon cost thirty centavos, a dollar could buy twenty-two of the coupons in Spain. If Ponzi brought them to the United States, those twenty-two coupons would be worth five cents each, or a total of dollar and ten cents. By redeeming them in Boston rather than Barcelona, Ponzi would earn a profit before expenses of 10 cents or 10 percent, on each dollar’s worth of coupons he bought in Spain and redeemed them in United States.”

He soon figured out that this would work with other currencies. On the Italian lira, with the same logic, he could hope to earn profits of $2.3 on every dollar invested.

But, there was a slight problem. As Zuckoff writes “The hitch, Ponzi understood, would be getting cash for the stamps he bought with the coupons. One possibility would be to sell the stamps at a slight discount to business that used large amounts of postage, giving them a bargain on a necessary item while still maintaining huge profits for Ponzi.” These details Ponzi thought could wait for later. But, as he would soon figure out, this would ultimately lead to his downfall.

What was now needed was money to exploit the opportunity. Ponzi started the Securities Exchange Company, and offered the investors 50% interest on 90-day investments. Though the certificate given to investors promised 50% interest in 90 days, Ponzi told the investors he would to shorten the pay-off period to around 45 days.

As the news spread, more and more people started investing in the scheme. At its peak, it is said that investors had invested around $15 million in the scheme. But Ponzi knew that even though he had a business model in place, he hadn’t figured out a way of earning money. He was essentially following the old scam of robbing Peter to pay Paul i.e. the money being brought in by the newer investors was being used to pay off the investors whose investments were maturing.

Soon the regulatory authorities came visiting. Ponzi, who had been thinking of other ways of legitimising his business, made a bold proposal to them. He decided to open the books of his Securities and Exchange Company to an auditor. The auditor would establish his liabilities. After that, his only job would be to show that he had the assets to back it up. Also during this period, no new deposits would be taken. Investors who wanted to redeem their investment before maturity would be given their principal back without interest.

Ponzi knew that every investor who withdraws before maturity, would mean lesser debt. His calculations told him that he had issued promissory notes of around $15 million. He had around $8 million with him, which meant he was $7 million short, Early withdrawals, he felt, would wipe out around $4 million in liabilities, after which, he would be $3million in debt. This he felt he could manage from a bank he was a director. After this, he would stop taking deposits and get into other genuine businesses for which he would raise money from the public, promising them a reasonable return.

But things did not work out as planned. The Boston Post kept doing stories to prove that Ponzi did not have a magic formula, and was only robbing Peter to pay Paul. On August 13, 1920, Ponzi was arrested. Sometime later he was convicted for 5 years in prison. 

And thus ended the story, of the man who wanted to be king, but ended up giving his name, to what is now famously known as the Ponzi scheme. On his death bed Ponzi finally admitted: “My business was simple. It was the old game of robbing Peter to pay Paul. You would give me one hundred dollars and I would give you a note to pay you one hundred-and-fifty dollars in three months. Usually I would redeem my note in forty-five days. My notes became more valuable than American money....Then came trouble. The whole thing was broken”.