It’s natural that some Americans see in the market’s recent convulsions evidence of a deliberate Chinese plan to crash the US economy. Economic warfare was, after all, a favored and often successful tactic of the Soviet Union. But the Soviets always calculated their risks and took logical measures: They moved when they had more to gain than lose. I’m thus more inclined to see in China’s precipitous stock-market decline the folly of attempting to circumvent the laws of economics.

In the past decade, alarmists have warned that China was poised to overtake the US. These warnings are reminiscent of those about Japan in the 1980s and 1990s. Some now believe China owns the US by virtue of its $4 trillion-plus foreign debt holdings. They survey China’s apparently rapid economic growth and conclude that China’s a major, unstoppable economic force.

China had logical economic reasons for accumulating US Treasuries. Despite the destructive economic policies of successive US governments, particularly this one, US Treasuries are still considered the world’s best credit risk. Although the dollar is a sorrowful currency investment, American debt instruments carry little-to-no risk of default. For nations such as China, which during the 1990s was barely credit-worthy and seeking to undertake major development projects with few cash reserves, leverage is the only viable alternative. But obtaining foreign capital investment requires collateral. China had none, save weapons; like the former Soviet Union, it relied upon arms sales to prop up its annual income. Creditors need to know that their investments are reasonably guaranteed in the event of insolvency. A loan backed by US Treasuries is a relatively secure investment.

Investors, particularly developers, were initially drawn to China because Beijing opened the door to capital appreciation. China had precious few regulations of the kind that strangle economic progress in the West, and offered a tacit promise to indemnify investors against capital loss. No wonder many so-called capitalists flocked to the Empire of the Sun. Incentives matter, and those are very attractive ones indeed. Thus began a major economic development program. China became the most favored location of those who sought to garner huge returns with little exposure.

Of course, China remained a communist dictatorship. That kind of power comes in handy. To fill demand for blue-collar labor, the central government relocated people who had only known life in rural villages to newly-reinvigorated metropolises. The PRC could easily supply unskilled workers in abundance, but lacked people skilled in business, science, engineering, communications, and technology. Employment opportunities in those areas became scarce in Hong Kong after the British withdrawal, so the skill went where it was needed: Residents of the former British Colony flocked to the mainland, despite their unmasked distaste for the PRC; the lure of huge salaries and low cost-of-living was irresistible. The economic growth their influx prompted encouraged similarly skilled people from other nations to rush there, too.

Naturally, to the casual observer it appeared that China was on the right path. Many who would otherwise fear and loathe communism found this communist nation quite agreeable. Some even speculated it was moving toward real market capitalism.

But this betrays a fatal misunderstanding of free markets.

Free enterprise, synonymous with sustainable economic growth, requires full exposure to profit and loss. A real market system needs profits: These create incentives to take risk, also known as investment. It also needs loss: This creates incentives to behave prudently. Attempts to control either part – profit or loss – ultimately condemn the entire system to failure.

China created a system where profits could be made easily and relatively painlessly. But it doomed itself by protecting investors from loss. The economy was driven by political expediency, not economic reality. Like US real estate, the Chinese miracle was a bubble, and bubbles pop.

Recently, physical structures in China have collapsed so often one might lose count. That’s what happens when you put up complex buildings, bridges, and infrastructure in haste. The cost in wasted capital and natural resources are nothing compared to the cost in human lives. These things were designed and built because they had immediate potential for capital appreciation, not because they were meant to be viable in the long term. Such is the nature of all get-rich-quick schemes.

With one investment after another crumbling down to its constituent parts, international investors are cashing in their chips. In a report for the Congressional Research Service, Wayne Morrison, Specialist in Asian Trade and Finance, notes:

[T]he Chinese economy has slowed in recent years. Real GDP fell from 10.4% in 2010 to 7.8% in 2012, to 7.4% in 2014. The IMF projects that over the next six years China’s real annual GDP growth will average 5.9%.

Now that foreign investment has ebbed, the Yuan is taking a pounding in the currency market. One way China might redress the issue is to follow the path of the Federal Reserve and inflate its currency. Instead, it’s selling foreign debt instruments. This does not automatically mean bad news for the US.

The revenue received from cashing in the US Treasuries has to go somewhere. Some of it will circle back to the US market in exchange for goods and services. China will also reinvest a sizable sum in its US enterprises. Moreover, those seeking to hedge might return a good portion of it to Treasuries. So what many see as a major divestment may in fact be no more than an asset swap.

The downside, of course, is that the Federal Reserve may act impetuously, as it has in recent years, and inflate the dollar before the market has had an opportunity to clear. This could be very bad for investors everywhere. We’ll see.

Naturally, everyone wonders if China, and more importantly, world markets, will weather this storm. Although we’ve all just taken a serious financial hit, I don’t see it as a fatal collapse. We’re nearing that day, but that’s another subject. In the near term, China will recover, although it will have to look more realistically at its economic policies.

They’d be well-advised to invest a bit of their hard revenue in a few economists of the Austrian persuasion.