To put this to bed, you can't upload images in to PMs. There is quite a lengthy discussion on this in the support forums for the software we use and the conclusion was that this is probably a good idea so that we don't have unseen unwanted images on our server. If everything is public then there is a degree of control.
The way around this is to use a photo hosting site such as Google Picassa and put a link to the image in your PM. They will show up, but they are sitting on someone else's server, not ours. There is a button in the editor to add an image - but if not you can do it like this: