Several issues.
China was not conquered, but reduced to a single chinese flagged territory.
We are fairly clear that:
When China, or anyone, has just two adjacent flags, those flags are in supply, because when trying to trace to two flags you can count the space itself if it is flagged.
China was reduced to one flag and could not trace to any US/CW sources. It had 3 PP left over at the time, does it keep these PP in storage indefinitely?
Various spaces in china are now in supply by sea, but no flagged space. Howevr, the US/CW could capture a chinese flag, and it would be in supply. Can china then (in the next turn) use that space to build, place units, collect income?
Would a chinese unit appear in the first initial phase, even though the space is occupied by only US/CW units?
If not, then what happens? Does the US/CW need to vacate before a chinese unit appears and then the chinese control the space, collect income etc? And would the chinese be able to do so on the turn that the chinese unit appears?
I am the Allied player, and what I do depends on what the japanese player does, although as he pointed out to me, but I was failing to grasp somehow, with my massive fleet/airforce I own the coast and can pretty much take any space I want on the coast of china.