Wow...rough position!
Odds are good that this is largely a bluff, but it's really hard to tell looking in from the outside.

A lot depends on who the employer is and who they know. If they really are someone or have access to someone, they might at least require you to move to another city or even province.

It's unlikely they could completely bar you from China. Even if you're placed on a SAFEA blacklist (and yes, there is one), there are plenty of schools who aren't part of SAFEA. Lots of schools won't look much further than seeing an available foreigner on the hoof. Just be upfront with any schools you apply to now. Make sure they understand the situation and are still sure they can get a Work Permit and Residence Permit for you.

Unfortunately, you may have to return home to get a new visa...doesn't seem likely you'll be getting a Release Letter from these guys...

Personally?
1. I won't tolerate a clearly abusive situation. If attempts to work it out fail, IMHO it's time to stop teaching and do whatever you can do.
2. I don't appreciate being threatened.
It might well be more costly in the long run to play along than to cut your losses and get out.