Lavazza1st. I am so very sorry for you. This is a terrible experience and it will take you a long time to come to terms with it. Please do not hold your son to blame for his responses to the situation. He was being manipulated by the trickiest kind of person one might ever meet, and he had obviously fallen in love with her too. I do not think he could act rationally in this tortuous situation, the poor man.
I can see that you know her behaviour has nothing to do with her nationality and has no cultural bases. I am sure, from my professional knowledge, she may have a mental disorder of some kind. But that is not for us to decide! The things she has done to you are extremely manipulative and the extensive lying - including the story about her granny chopping logs which I also do not believe - plus the petty business of holding her son up to break lamp shades... it all adds up to something far more complicated than a normal person going through a difficult patch!
I think you have to accept that your DIL had a mental disorder of some kind, even though you are not able to get a diagnosis and even though it may be unethical to say so to anybody. But here, where none of us knows her or you, we can say that this behaviour is too extreme to be normal and that she probably will never be somebody you can ever reason with.
I am very worried about your poor son. He has a child by an unbalanced woman and is trying to please her and meet her unreasonable demands. In the end she will ruin him. Such people are impossible to please. She will keep him dancing on the end of her piece of cruel string while he tries to do all sorts of ridiculously unreasonable things to keep her happy. Eventually he will collapse or lose his job or a crisis of some kind will happen. It goes without saying that you know that whatever she wants she makes it impossible for you to achieve. So she will do this to him. It is part of her disorder, although you are in the position whereby you cannot say this outright. You could just stick to the facts, that is the things she does. Just observe that the behaviour and the things she demands are unreasonable and impossible to achieve. Keep a note of them. It is very easy to forget or get so tied up you "can't see the woods for the trees". Tell your son that the sooner he establishes his boundaries about how he needs to be reasonably treated the better. Also about how she looks after his son.
He needs to set the ground rules. However, she will not be reasonable, this I predict, so do not expect it. But if the ground rules have been made, then you/your son can establish that she is being unreasonable. Most importantly he has to ensure the safety and health of his son. This is such a priority because I fear the child is not in safe hands with her. While she is getting her own way, including enjoying hurting people, she will probably take reasonable care of her son. However, as he grows and makes more demands, I fear she will resent the time he takes away from her being able to do as she wants or get her own way. She will use him to blackmail your son.
I am so very sorry. It is terribly difficult because you are in the early stages of disbelief. You and your son are still trying to imagine what is going on in her head and are trying to find reasons for what she is doing. People here will clutter the issue by matching her against their normal rationale for such terrible behaviour and think up excuses. But she is not normal. You cannot imagine how she thinks because she does not apply the rationales and reasonings and even the ethics that normal people use to think about a situation. You just can't "get inside her head". Your son especially is not able to take in that his wife is mentally not normal. It is very important that he starts noticing how strangely she behaves and that her reasons for doing so are not really what normal people would say. Not on this scale, at least. You all need to keep a note of her lies. It could take some time for him to realise she is not quite right. I sincerely hope he does not sacrifice too much before then.
You really need to think in terms of damage limitation and the welfare of the little boy. The future is going to be a divorce and custody of his child when she will be in China with him. At some point he will need your help and support. Sorry! You must hope for the best but - in this case especially - be prepared for the worst!
Sorry. I have been concise which means it has been very direct and tough to take in. I am so very sorry. 