Why does my micarta handle go chalky when I sand it?

Totally normal, you didn't ruin anything. Micarta (linen or paper, sounds like linen from the color) goes pale and fuzzy when you dry sand it because you're leaving the fabric fibers raised and frayed. The dark look you see on finished handles comes from wet sanding, which keeps the fibers laid down instead of standing up like a fuzz blanket.

So yeah, wet sand. Start back at 220 with some water or a bit of mineral spirits, keep the surface wet, and work up through 400 and 600. The color comes back as you go and the handle will look nearly black-brown again while it's wet, which is basicly the finished look. You'll notice the difference immediately on the first pass.

For the waxy look you're describing, most people finish with oil after the last grit. Boiled linseed oil, mineral oil, tung oil, even just a wipe of any of those will darken it up and give that slightly glossy or waxy appearance. Some folks do a light buff with wax on top. I've also had good luck just rubbing in a couple coats of BLO with a rag and wiping off the excess after it sits a few minutes.

Don't worry about sanding through anything at 220, micarta scales are usually way thicker than you'd ever cut into. The chalky fuzz is just surface texture, not material loss. And the fibrous grip you're feeling? If that's the look and feel you want, you can stop at a lower grit wet sand and leave it. A lot of working knife makers intentionally finish micarta rougher for grip. But if you want the smooth waxy handle look from those other posts, wet sand fine and oil it. The nice part is you can always rough it back up later if you change your mind.

Funny timing, I just went thru almost the same thing last month. Mine was homemade micarta out of a pair of old jeans and epoxy, and I panicked at the exact same chalky stage. One thing I figured out after the fact: watch the edges where the scales meet the brass. Oil creeps into that seam and can leave a dark ring around the pins if you flood it on. Thin coats wiped off quick fixed that for me.

Question for anyone who's carried one a while, does that oiled finish hold up in the pocket, or does it go dull and patchy after a few months? Wondering if I shold just plan on re-rubbing it now and then.

This helps a lot, I was picturing having to redo the whole handle. I tested a corner of one scale with wet sanding like you said and the color came right back, kind of blew my mind. I used plain water since I don't have any spirits yet. One thing I noticed though is once that spot dried it went a bit pale again, not as bad as before but not the wet look either. Does the oil at the end keep it dark permanently or does it fade over time and need redoing?

Update: wet sanding was the answer, fibers laid right down and the brown came back almost instantly. Worked through 220 up to 400 with water and it looks like a real handle now. Also glad I caught the warning about oil wicking into the pin seams, I'd have defintely slopped it on and made a mess of the brass.