It would be only a year before anything resembling socialism in power vanished from Westminster. Yet to the guests gathered for the farewell garden party at 12 Kensington Palace Gardens, London, one day in 1978, such an outcome must have seemed unlikely. The aristocratic residents, the Cholmondeley family, hereditary Lord Great Chamberlains, were selling up and moving out after six decades. The future seemed to belong to the trade unions, to the Soviets - who had begun acquiring diplomatic premises in the street in the 1930s - to the Arabs and Iranians, squelching with money after the 1973 surge in oil prices, and to a horde of spotty, uppity, lefty graduates contemplating the staid notion of a mortgage in the dingy enclaves of Notting Hill, Camden and Islington.

A generation later, the fact that the aristocrats had nothing to worry about is the least surprising aspect of what we know. What is remarkable is that the very manifestations of upper-class anxieties turned out to be the means which would not only secure the private possession of wealth in Britain but inflate it, in the early years of the 21st century, to staggering new levels.

The trade unions, arguably, paved the way for Margaret Thatcher's wealth-friendly government in 1979. The oil money that began pouring out of Britain into Iran and the Gulf in 1973 began almost immediately to tip straight back: the buyers of 12 Kensington Palace Gardens from the Lord Great Chamberlain were the Saudi royal family, who still own it. The scary Soviets turned into free-spending Russians who, like the Arabs before them, are bringing the billions they earned from the west for their raw materials, back to the west. Those graduates turned into Blairites and Cameroons, stars of the bar, the arts and the media, with school fees and million-pound houses. As for the Marquess of Cholmondeley, he's still up there: number 666 on the Sunday Times Rich List last year. In other words, he's only borderline super-rich.

London has attracted the extremely rich from all over the world as a place to live and tend money at least since the 19th century. Today, the impression is growing - subjective, anecdotal, hard to pin down yet confirmed by those who deal regularly with the very wealthy - that gigantic fresh waves of private wealth are breaking on Threadneedle Street and Kensington. The wealth may ebb and flow, but it always leaves something behind for those many, many Londoners whose business it is to make money out of money.

"It's very difficult, objectively, to say how much bigger the wealth management market in London is, because of privacy. But it certainly is bigger," says David Harvey of Step, the Society of Trust and Estate Practitioners, a London-based global association of tax lawyers and financial advisers whose members, scattered across the business centres and tax havens of the world, are unashamedly dedicated to helping wealthy families keep their riches from the taxman.

"New York is obviously very stable, but most of the other big centres would have questions over them," says Harvey. "Tokyo's gone through a period of depression. Singapore is relatively new. Shanghai, you would question that, and Germany was until recently seen as a tax-heavy jurisdiction. If you're looking to avoid tax legally, you're as well going to London as anywhere else."

The government doesn't issue figures on the movements of private wealth in and out of Britain, let alone offer guidance on how much is here already. The most recent numbers (from 2003) show Britain owning about £3.5trn worth of abroad, and abroad owning about £3.5trn worth of Britain. The figures haven't changed much from two years earlier; nor do they distinguish between businesses and individuals.

London's most expensive residential streets, such as Kensington Palace Gardens, offer a better guide to the changing nature of the private money flooding into the capital. Even 10 years ago it seemed likely that private residents would vanish from these gigantic, early-Victorian villas, unless they were turned into flats. They were seen by estate agents as too expensive to sell. Now at least three, and possibly four, super-rich millionaires, including the world's third richest man, Lakshmi Mittal, have private residences on the street.

"There was a time when huge houses in somewhere like Kensington Palace Gardens would have been inconceivable as private homes, because they were too big," says Dick Ford, head of London residential sales for the elite Mayfair-based estate agency Knight Frank. "Only an embassy or some kind of institution would take them. Now everybody wants them as private houses."

Kensington Palace Gardens, sometimes known as KPG to its residents, has never been a street for the poor. The former kitchen gardens for Kensington Palace were sold off by the royal family for housing in the early 1840s - the freehold still belongs to the Crown Estate, which passes the proceeds of lease sales on to the government - and by 1854, almost all the houses were complete. It was always a home of new money, of financiers and traders, alongside the procession of dukes and earls. But by the 1970s, when the London property market went through the floor - a house on Regent's Park that Knight Frank sold in 1973 for £200,000 was sold a year later for £97,000 - it seemed likely that the street would be embassies-only for ever more.

It is still home to the embassies of Russia, Nepal, Lebanon, Kuwait, Japan, Saudi Arabia, Slovakia and the Czech Republic, to the Sultan of Brunei and the Saudi royals, to the French and Finnish ambassadors and the Indian High Commissioner. But Mittal, estimated by Forbes magazine to have a personal fortune of £14.8bn, now lives there too, in the house once occupied by Baron de Reuter, founder of the Reuters news agency. According to the Land Registry, he paid just over £57m for the house in 2004 - the same year he blew a reported £31m on a six-day wedding party for his daughter and 1,000 guests in Paris that involved Versailles, a specially built wooden castle, a private performance by Kylie Minogue and 5,000 bottles of vintage champagne.

Mittal's next-richest neighbour is Len Blavatnik, the Russian-American tycoon, who moved in last year. One of the most private rich Russians, nobody outside his circle knows exactly how much liquid wealth he owns, but figures of multiple billions are bandied about by the guesstimators and his ownership of stakes in Russian oil and aluminium companies makes this plausible. He emigrated from the USSR to the US in 1978; he didn't begin to investigate the new Russia until 1990, when he returned from New York with a few million dollars in the bank and a Harvard business degree.

Jonathan Hunt's presence as a KPG homeowner is a reminder that far from all the big new private wealth in London being from overseas, the number of extremely rich Britons, and the size of their fortunes, is on the up. Hunt founded the Foxtons chain of estate agents; he paid £14m for his house in Kensington Palace Gardens in November, a town house to go with his stately home in Suffolk.

There may be another mega-rich private resident on this street. A document filed with the authorities in Luxembourg, setting up a trust and available on the internet, gives a house address in Kensington Park Gardens as the home of a fabulously wealthy art collector, the former CEO of an Israeli insurance company. Unlike Hunt, Blavatnik and Mittal, his suspected purchase hasn't previously been made public. It would be good to be certain; it would be nice to say that, for this article, I was able to charm billionaires and hundred-millionaires to their doorsteps to tell me why they chose to live in Britain. But the thing about fantastically wealthy people is that they never need to speak to a journalist. For every gabby tycoon, every Richard Branson, there are a handful more whose faces will be seen at parties and post-deal press conferences but are otherwise private; and many more who are, to the public, completely invisible.

I sent registered letters to all the private residents of KPG, asking them why they lived in London when they could live anywhere. The letter to the Hunts was returned without comment; the letter to Blavatnik triggered a phone message from an assistant, John Stoneborough. "He's a very private chap," said Stoneborough. Mittal and the art collector didn't reply.

The government may not track the increasing wealth of British richest residents, but others try to. Newspaper rich lists go some way towards penetrating the veil. Yet they often quote, as wealth, shareholdings in companies that cannot be sold without destroying confidence in the company. There is also the temptation to characterise someone as living in Britain just because they have a house here. Roman Abramovich, the owner of Chelsea FC, does own homes in Britain and is often described as Britain's second-richest man after Mittal; yet he owns residences in Russia and France, too, and his official position, stated by his assistants in Moscow, is that he lives in Russia and only visits the UK for matches.

A firm specialising in studying the spending habits of the very wealthy in Britain, Tulip Financial Research, employs a different approach. Using a computer model, it looks not at overall wealth but liquid assets - cash and the things people own that could quickly be turned into cash. The firm's most recent survey suggests that, in the five years since 2000, Britons' liquid assets have increased by more than 50%, far ahead of inflation, from £1trn (that's £1,000bn) to £1.6trn.

Tulip follows the standard division of the rich into four classes. First is the "mass affluent", 4% of the population, who now have average liquid assets of £144,000. Then comes the High Net Worth (HNW) individuals, 0.7% of the population, with average liquid assets of £665,000. There are 135,000 people in the third class, the ultra-HNWs. What this means is that Britain contains a community the size of Peterborough whose average liquid assets (which doesn't include their first or second home) average £6.4m. This one group, 0.3% of the population, owns almost half the liquid assets in Britain, and they are on average 66% richer than they were five years ago. The last group, the super-rich - the thousand richest individuals in Britain - have seen their liquid assets increase by 79% in five years, to an average £70m each.

"Of course," says John Clemens, managing partner of Tulip, "You have to remember that 30% of the population owns no liquid assets at all."

If there is more private wealth in Britain, and in London in particular, than ever before, where is it coming from? One explanation is that in the past few years London has become, even more than in the 1990s, the world's conduit of choice for private wealth. Its generous tax treatment of the mega-rich, particularly those born abroad, makes it in some ways a virtual tax haven. The old snobberies of race and class have partly yielded to new snobberies of money and beauty. That, and its combination of attractions - political stability, relatively honest officials, a host of ingenious tax-avoidance specialists, an army of cheap immigrant labour, the luxury shops, restaurants and clubs that charge prices high enough to reassure the wealthy that they are special, the resident celebrities, the cultural energy, the existence of a vast City within the city dedicated to money - mean only New York is London's peer. And there, despite the Bush administration's income tax cuts that have gone disproportionately to the very wealthy, the US Inland Revenue Service and Wall Street regulators have a reputation for being fastidious with the rules.

"The IRS is perceived to be a much more burdensome tax regulator than the UK Revenue," says David Harvey. "The UK tax authorities take the approach that it's much better to fight over a small piece of a very large cake."

Seb Dovey, of the London-based wealth management consultancy Scorpio Partnership, says: "I wouldn't say as a professional centre for private banking London overtakes Switzerland, but it does punch higher than any of the other European countries ... if you're an emerging rich person or a multi-billionaire, London is the place to be. Those from the Middle East and India would use Switzerland as a bank-deposit location, and their active money in play would be managed out of the UK."

"I think the super-rich want to have two homes, one in New York and one in London," says a British hedge fund manager. "The bulk of the super-rich want to spend their lives in these two cities, but if they're based in New York, they would pay a lot more tax than here."

"The great problem with the US is it's very self-sufficient," says Caroline Garnham, a tax lawyer with the City firm Simmons & Simmons. "Great wealth has been made in the US, but people from elsewhere don't go there for investment management because the US doesn't understand the rest of the world or different cultures.

"It's recognised that we have the leading investment managers in this city, leading not only in ability but in innovation. Although Switzerland has a huge amount of wealth sitting in bank accounts, usually they're just put in bonds, and haven't really moved into the equity market, let alone all the other fun stuff we put it into."

One of the big tax advantages for super-rich British residents who aren't British-born is this country's unique "non-domiciled" tax rule, which allows tens of thousands of wealthy people to avoid paying tax on income earned overseas. Almost four years after an investigation by Nick Davies in this newspaper showed how the Swedish billionaire Hans Rausing, then described as "the richest man in Britain", had in one year received more from the Treasury in refunds and grants than it was getting from him in tax, the government shows no sign of closing the loophole. "Non-domicile is much bigger than people think. It's massively important," says the hedge fund manager.

The rise in the price of oil since 1998 has given the Gulf countries an extra $1trn in revenue, he points out, but since 2001, Arabs benefiting from that windfall are less likely to manage their wealth from the US. "I know this bloke who runs a $50bn fund of Arab money. He's been investing in America for 30 years, but every time he goes there now, he's treated like a convict. He has to show his passport at every meeting."

The hedge fund manager's Arab story chimes with another explanation of the London private wealth phenomenon - that, worldwide, there is simply more money sloshing around in the pockets of private individuals. Until recently, most of the globe (the US was the main exception) functioned according to three assumptions of what was "normal". One was that large chunks of the economy would be owned by the state and run by civil servants on modest salaries. A second was that the exceptionally wealthy should pay much higher taxes than other people; third, that governments would stop individuals moving their money freely from one country to another.

These assumptions have been challenged or rejected across great swathes of the planet, including Britain, China, the former Soviet bloc, India, south-east Asia, Africa and Latin America. State enterprises have been privatised and the civil servants who ran them turned, in many cases, into millionaires. Economic orthodoxy sees high taxes on the rich as an evil - in Russia and other former Soviet-bloc countries, the rich and the poor now pay exactly the same income tax. Company bosses are not embarrassed to take millions, even billions, out of firms in salaries, dividends, bonuses and stock options, while big money flies across most state borders as lightly as birds.

The Thatcher government pioneered the change in Britain in the 1980s, privatising industries, cutting taxes and abolishing controls on the movement of money in and out of the country. The rest of the world followed; the tighter the state's grip on the economy in the first place, the faster wealth flowed into fewer private pockets. Russia was, and remains, the most extreme example.

Until 1986, the number of legally rich Russians in Russia was, in effect, zero. In a recent article in the British magazine Wealth, Andrei Movchan of the Moscow firm Renaissance Capital Management estimated that there are 500 super-rich Russians with assets of more than $300m, another 5,000 with upwards of $30m, most of it already moved abroad, and as many as 115,000 million-dollar households. For a country which is only spending $85 a year per person on health care, it is a staggering concentration of wealth in a few hands in the space of a single generation. And while much of that money is stashed in Switzerland, Cyprus or Delaware, a good proportion has flowed into the UK.

But there is a third possible analysis, which suggests it's not so much that private wealth in London is greater than it was 10 or 20 years ago - it's just that those who have it are more inclined to flaunt it. Tatler, the 300-year-old magazine that documents the social doings of Britain's high-visibility rich and which has, according to its editor Geordie Greig, the richest readership in Europe, recently ran a spread headlined Party Awards 2005. The party narratives were replete with artificial snow in midsummer, a private tour of the Sistine chapel, caviar by the kilo, synchronised swimmers and naked women on white horses, foie gras risotto covered in gold leaf, a masked ball in a St Petersburg palace and live black fish flown in from the Caribbean to swim in the bottom of flower vases. The last award reads: "Best effort in the face of adversity - Bettina Bonnefoy, for going ahead with her Peter Sellers-themed party on the day of the London bombs."

"I think we are in an age of staggering riches being spent and earned," Greig told me. "People will pay £250,000 at a charity auction for their son to escort David Beckham on to the pitch at a football match."

When you're a billionaire, you don't live anywhere, and neither does your money. Or rather you live everywhere, and so does your money. "I think the wealthy house their money everywhere, and London seems a logical place," says Rory Sherman, of the US magazine Trusts & Estates. To the modern super-rich, she says, anyone with a mere $5-10m is "trailer trash". "I think the fabulously wealthy have become more fabulously wealthy, and they have lots of places to put their money."

There are no billionaires sitting in a room staring at their wealth stacked, liquid, in bundles of dollars around them. The bulk of their wealth is always in motion, breathing, expanding and contracting. Only by the sparkly feathers that flutter to the forest floor, the golden spoor on the trail and the remnants of its prey can you tell that there was a billion and that it passed this way.

The billions never stand still for long. Those who hope to catch a piece of them as they race by have to be adept at slicing bits off them as they pass, or by helping them to pause and feed, or by providing a nice rough bit of bark for them to scratch on. And London is very good at that.

The fact that many of the wealthiest "British" residents actually reside everywhere and nowhere, between London and Moscow or Monaco or countless other cities and islands around the world, deflects attention from a deeper truth - that often the thing which most concerns the very rich is time, rather than geography. Their only true domicile is their own family, and the most obsessively fretted-over question is how to pass wealth from generation to generation without it being eaten away by taxes or thrown away in casinos and divorces by children and grandchildren. The ultimate symbol of true wealth in 2006 is not a Bentley or a house in Kensington Park Gardens, or a diamond as big as the Ritz. It's something called a "family office" - a full-time team of lawyers and accountants dedicated to the sole aim of protecting and cultivating one family's wealth further into the future than most governments, let alone ordinary people, would ever dream of planning. David Harvey of Step suggested that a sensible rich family would be advised to think 100 years ahead. "For a lot of families, the question is: can we take it as far as generation three?" he says.

For the Benzon family, which in the 19th century occupied the Kensington Palace Gardens house now owned by Jonathan Hunt, the answer was "no". Great wealth can, and does, vanish swiftly if heirs prove incapable of bearing its weight. The iron merchant Ernest Benzon drew guests as notable as Felix Mendelssohn, George Eliot and Robert Browning to his lavish salon. In 1889, Benzon's grandson, also called Ernest, described what then happened to the family fortune in his book, How I Lost £250,000 in Two Years. The chapter headings chronicle the dissolving of a fortune worth between £20m and £110m in today's money: Coming of Age, Racing Experiences, Gambling Experiences, The Ring, Money Lenders, Monte Carlo and Pigeon Shooting, London Tradesmen. Before losing his last shilling on the roulette wheels of the riviera, Benzon once gambled away £10,000 at chemin-de-fer during a 10-minute wait for a train.

Seb Dovey says there are about 2,500 active family offices across Europe, three times that number in the US- worldwide, perhaps 11,000 family offices, each with more than $100m to invest. "It's significant that the rate of new family offices opening up has increased," he says. "We now estimate about 20 new family offices are being set up across Europe every month. In the UK, that means two or three offices a month."

When you talk to someone such as Caroline Garnham, an expert in setting up family offices with the City law firm Simmons & Simmons, you realise that the notion of the very rich being citizens of their own family, rather than citizens of any one country, isn't entirely conceptual. Garnham, whose firm dominates one of the City's newer, larger steel-and-glass skyscrapers, talks about "family governance". Her advice to a super-rich family involves them moving from what she calls "dictatorship" and setting up a kind of family parliament.

The tedious, ultra-specialised task of setting up a legally watertight constitution for a family democracy is one in which London excels, Garnham says. "A lot of this wealth structuring on a global basis happens out of London and this can often be with someone who has no connection with England whatsoever ... They won't keep their money here, because of our inheritance-tax regime, but they will have it managed here."

A rare academic study of the changes in wealth and income in London in the past few decades, Unequal City: London in the Global Arena, by Chris Hamnett, points out that as it has grown wealthier, the capital has gained population. In 15 years, London has grown by the equivalent of a city the size of Frankfurt. It has also grown more unequal. The gap between the richest and the poorest citizens has increased radically.

At the same time, the direst Marxist predictions of the consequences of rampant capitalism have not come about - inequality, says Hamnett, isn't the same as polarisation. There aren't more poor Londoners now than there were 30 years ago; but most Londoners are poorer relative to the very richest residents.

In this, London, and Britain as a whole, could be seen to be following in the footsteps of the US - an economic paradigm for Thatcher and for Gordon Brown. Across the Atlantic, even some conservative commentators are uneasy about the degree to which the wealth of the very richest has grown, while the wealth of the middle classes has stagnated or shrunk. Yet London and the country of which it is capital may be trapped, hooked on the world's money to a degree that would be difficult to replace. A million Britons work in the money management business; Britain has a trade surplus of more than $25bn in financial services. For every campaigner and journalist pointing out the apparent inequity of the non-domiciled rule and other tax-avoidance schemes, there is a lobbyist or three arguing that, far from being too much like an offshore tax haven, Britain should be more like one, a sort of extra-large Grand Cayman, because that's what we're good at in a competitive world, working the game of fees and percentages with the planet's rich.

"I've always thought that England would benefit a lot by becoming an 'offshore haven'," says Garnham. "It's already halfway there. Why not make more of it? We're only a tiny little island".