For dedicated followers of fashion few possessions are more likely to increase your credibility than the ownership of contemporary art. A Damien Hirst spot painting between drawing room sconces will immediately identify you as a broad-minded person of with-it interests, and filthy rich to boot. At up to £100,000 a throw, one of Hirst's brand images, whether it's a spot picture or one of the 'swirlers' he makes by pouring paint on a revolving canvas, will set you back far more than most of the best Old Master landscapes. His museum-size picklings cost even more, up to half a million, but you can get a codling or a haddock in a perspex box (let's call it a sketch for the shark) for the mantlepiece at the price of a sports car. Britain's young artists, those who get nominated for the Turner Prize and were included in the Sensation show at the Royal Academy, are now the New Academy, blue chip. Corporate collections in the City are buying them up and, in tamer manifestations, they were even endorsed by No 10 during the early, hottest flushes of 'Cool Britannia'.

But hang on a minute aren't Damien Hirst and his Turner Prize pals supposed to be the avant garde? How has what was supposed to be an irreverent alternative to conventional art come to be accepted as the establishment line?

The truth is that the New Academy, of which Damien Hirst is the best known brand name, has become the cruellest, most exclusive of State tyrannies. The Turner Prize, which is the Academy's annual Salon and which prospers on controversy and publicity, has just opened to a predictable deluge of indignation. The centre of attention has been Tracey Emin's installation, My Bed. There is no art in this mere document but that hardly seems to matter. Many will be attracted to this display in the same way that they would be teased into a fairground tent to see 'The Hairiest Woman in the World', crowds which the Tate Gallery will assume in its perverse way demonstrates the overwhelming popularity of New Academy taste. By the way, one of Emin's thirty-second smutty drawings complete with four-letter words (five in her case she spells so badly) would have set you back four grand before the controversy, but it'll probably be double that by the time you read this. The Turner Prize is a game played by the main players in the new Academy; namely, the Tate Gallery, the Arts Council and a handful of wealthy, highly influential commercial galleries in London. Dwell on this: nine of the fourteen winners of the Turner Prize have been represented by two commercial galleries. This cosiness indicates the small number of individuals involved, so for the record the Academy members are: three art dealers, Anthony d'Offay, Nicholas Logsdail of Lisson Gallery (one of whose directors is a former employee of the Arts Council and also a former judge of the Turner Prize) and Jay Jopling of White Cube, who represents Hirst and Emin; three Tate employees, Sir Nicholas Serota (who speaks also for the British Council, which acts as the export arm of the State Academy), Lewis Biggs, head of the Liverpool Tate (and also on the Arts and British Councils) and Lars Nittve, a Swede appointed to head the new Bankside Tate, the building which promises to become the State Academy's bunker; three from the Arts Council, artists Antony Gormley and Anish Kapoor and the head of visual arts, Marjorie Allthorpe-Guyton (who also serves the British Council and judged the Turner Prize when Gormley won it); six directors of Arts Council funded galleries in London and the provinces (Serota is formerly a director of two of these); one critic, the reliably uncritical Richard Cork, who has moved widely in the Academy's circles; and one extremely influential Tate trustee, Michael Craig-Martin, an artist Professor at Goldsmith's, the preferred art college of the State Academy and the country's main production line for conceptual artists. Apart from these seventeen fixers, who have overseen the institutionalising of the avant garde and who make or influence every important strategic decision taken in the contemporary visual arts, there is one other critical Academy member, but we'll come to him later. At the centre of the Turner Prize is Sir Nicholas Serota, who chairs the judges who he has a big say in choosing so that they deliver the necessary 'cutting edge' shortlist.

The Arts Council of England, though seemingly unrelated to the Turner Prize, is of crucial consequence in the State Academy's modus operandi. In recent months the money available to the Council has more than doubled to around £500 million because lottery money earmarked for the arts has been dropped into the same pot as the body's annual government grant. The recent history of the Arts Council in funding the same clients every year, not to mention the backscratching, conflicting and vested interests infecting the entire organisation, would need a pamphlet of its own to document. Suffice to say that to give this body all the lottery cash as well is like entrusting a drug addict with keys to the dispensary.

The eight art galleries which were all founded in the last 20 years and which receive the bulk of their revenue from the Arts Council, and whose directors are always former employees of the Council, show only avant garde work. They are uninterested in and probably unaware of anything else and there is no longer any pretence to showing the diversity of art currently practiced. They stage no history shows, and older, even well-established artists, especially if they are conservative enough to be painters, need not apply. Likewise young artists of a conventional bent.

The careers of potential Turner Prize nominees are nurtured in these state subsidised seedbeds which also show the work of established 'cutting edge' artists. For example, in the last year the publicly funded South London Art Gallery has staged major shows of two successful young artists, Gavin Turk and Marc Quinn, both represented by Jay Jopling's White Cube. It is debateable whether public money should be spent reinforcing the reputations of those who have already made it.

Two of the Arts Council's all-powerful controlling panel of ten are artists Antony Gormley and Anish Kapoor. Once again, a pamphlet could be written on each of these demonstrating how their careers were nurtured by publicly funded galleries and commissions. When appointing Gormley and Kapoor, chairman of the Arts Council Gerry Robinson described each as 'independent', a remark of breathtaking ignorance. As regular beneficiaries past and present of the Arts Council they are hardly impartial. Additionally, as former Turner Prize winners both are represented by wealthy contemporary art dealers (Gormley by Jopling), dealers whose other artists may also be hoping for exhibitions in Arts Council venues and lottery money for public art schemes.

One recent example demonstrates the dangers inherent in a system where recipients of money are also responsible for handing it out. The current exhibition at the publicly funded Serpentine Gallery (£350,000 p.a.) features Jane and Louise Wilson, twins who work as a team making multi-screen videos of stultifying banality. Notwithstanding the curious coincidence by which the show is timed to synchronise with their Tate Gallery display, for they too are nominated for this year's Turner Prize, the most tedious of the three films shown was shot in the Palace of Westminster. In order to make it they were awarded an Arts Council lottery grant of £19,140 (incidentally, they also received £10,000 last year from the Arts Council). The Wilson twins are already successful, widely exhibited artists who were nominated for the Turner Prize on the back of exhibitions in Hannover and the USA. They are represented commercially by Academy member Nicholas Logsdail's Lisson Gallery, one of Europe's most successful and wealthy dealers in contemporary art. Five of their artists have already won the Turner Prize. Why didn't Lisson Gallery accept normal business risks and fund the new video? It seems that for the handful of dealers who supply artists to the Turner Prize shortlist, the process of creating new work may be made risk free. Public money can be used to underwrite new work which, once the endorsement of exhibiting in a publicly funded venue has been achieved, may be sold for the profit and enhanced reputation of artist and gallery alike. Does this not represent a misuse of what we are insistently told are scarce resources for the arts? By the way, Anish Kapoor, like the Wilson twins, is represented by Lisson Gallery.

This brings us neatly to a long-time supporter of the Serpentine Gallery, and also coincidentally a buyer of work by the Wilson twins, Charles Saatchi, for he is the earlier unnamed member of the State Academy in which only Serota wields more clout, and even that's debateable. Despite flamboyant claims to being reclusive, Saatchi's activities always manage to leak out. As we know he is an advertising magnate, one who by profession understands that promotion, hyperbole, branding and the visibility of a commodity are more important than its perhaps less tempting reality: superficiality at the expense of substance. Damien Hirst, for example, is virtually the creation of Saatchi, who owns the artist's most important pieces.

Saatchi has used his considerable wealth to corner the market in Turner Prize art, which he has bought and sold in staggering quantities, often purchasing entire exhibitions. Barely any artist on the State Academy's books has not had their work owned in bulk at some stage by Saatchi. Over the last fifteen years, precisely that period during which the institutionalising of conceptual art has taken place, he has probably bought and sold more work than any other individual in the entire history of art. He is referred to as 'a collector', but he shows none of the discerning, discriminating instincts characteristic of one. Reports of his buying sprees would suggest that he more likely suffers from a chronic addiction to shopping. Ten years ago he jettisonned a massive holding of blue chip 20th century art and fashionable British work and began volume purchases from unknown artists, in some instances coming to own virtually their entire oeuvre. He loans and donates work to the Tate Gallery and the Arts Council, the latter being given 100 works by 64 artists from the Saatchi warehouse last year alone. Rapidly, Saatchi has assumed a position akin to a stock market guru: when he buys an artist's work it is a conspicuous endorsement and others follow suit; when he sells the artist's reputation is left dead in the water. He was and remains that powerful. The precise mechanics of how reputations have been stage-managed and marketted during the 1990s will probably never be known, but the truth is that throughout this decade, the few art dealers who matter, and especially Jay Jopling, have learnt from Saatchi the value of publicity for its own sake. Thus have we arrived at the bewildering stage where an artist is only as good as the publicity they generate. Tracey Emin is a star because she has a modest genius for self-advertisement. The fact that she can't draw, can't write, is thick and has no creative imagination is immaterial because in today's populist Britain these are not impediments to success. In her way she is the personification of State Art in the 1990s: a complete nonentity promoted as the champion of all possible accomplishments. Naturally, Saatchi owns Emin's most famous work.

The way the artists bought by Saatchi and represented by avant garde dealers have had their careers charted and controlled by gossip, media manipulation, in particular newspaper features, has been awe-inspiring to observe. It was recently stated that the first thing a graduating art student should do is sign up with the most expensive PR consultancy they can afford. This was no glib exaggeration.

Accompanied by auction records tumbling all around, in the last two years Saatchi has been selling works by those artists featured in the Sensation exhibition at the Royal Academy in 1997. It was of course a considerable coup for a dealer to have his stock exhibited so prominently in the capital's finest galleries. The same show is currently attracting record crowds in Brooklyn following a publicity campaign of exquisite genius which even suckered Mayor Giuliani of New York into the conspiracy.

One can only guess at the real influence of Charles Saatchi in the evolution of the State Academy, but wherever one probes there he is, the eminence gris pulling strings in the background. He crops up everywhere. When the winner was announced a fortnight ago of this John Moores Prize, Britain's major painting award and one which has been taken over by the State Academy, it came as no surprise to discover that virtually all the work of the unknown winner, Michael Raedecker, was already owned by Saatchi. Incidentally, the Moores' was judged this year by Times art critic Richard Cork, who was until last year Chairman of the visual arts panel of the Arts Council, and another State Academy member, the director of an Arts Council-funded gallery in Birmingham. Needless to say both are also former judges of the Turner Prize. A few days after the Moore's winner was announced a press release was published announcing the large sculptures planned for the outside of the millennium dome. Predictably, both Arts Council Academy members, Kapoor and Gormley, were winners and all but two of the seven artists were former Turner Prize nominees. Who were the judges? Richard Cork, naturally; the director of the Serpentine Gallery (Academy member); a former employee of the Serpentine Gallery (trainee Academy member); the Tate's Lewis Biggs (Academy member), who sits on the visual arts panel of both the Arts and British Councils and himself received £1.7 million of Arts Council lottery money last year to curate the abysmal Artranspennine98 sculpture sprawl; Richard Calvocoressi, formerly of the Scottish Arts Council and currently a member of the British Council's arts panel; and, finally, none other than Saatchi himself. It had already been announced a fortnight earlier that Saatchi's ex-wife, who happens to be a rich collector of State Academy work but has neither critical nor art historical credentials to speak of, selected works for the dome's interior. Are there so few capable of discrimination that a speculator in contemporary art like Saatchi has to do the choosing? He is, after all, a dealer with financial interests in certain artists, including, you won't be surprised to hear, three of the seven (he's already unloaded a vast holding in a fourth) he helped select for the dome project.

Rarely a week now passes without an example of the State Academy consolidating its influence. Permutations of the same few judges select/curate/promote/advance permutations of the same few artists. The story of the byzantine workings and wheeler-dealings of how so few people managed to institutionalise avant garde art, so much of which exhibits so little discernible merit, to the financial advantage of so few, will doubtless be written in the future by those with the time to probe deeply. For the time being, the art of Damien and his pals is as secure an investment as gilts, for both are state-sponsored.

David Lee is editor of Art Review