The plot is confused. The "Floating Dragon" is - perhaps - partly supernatural, though primarily it is explained as a leaked Department of Defense gas, that drives people insane and eventually liquefies their bodies. While losing their minds, the unfortunate victims hallucinate - hence, the possibility that what is being perceived as a recurring supernatural evil is all in the mind of the beholder.
I really disliked this book when I first read it, but I decided it required a re-read in later years after overcoming my initial disappointment. It was much better than I remembered it, but its flaws still gravely weaken it. Really, it's all quite good until the last seventy-five pages or so, when the action becomes completely hallucinogenic and virtually impossible to follow, and the ending is terribly trite to the point of being laughable. Straub's worst trait is a tendency to go way over-the-top, and that is at its worst here. But his characters, as usual, are quite memorable, and his writing in every other regard in typically splendid form.
If you're a Straub fan, this one may or may not put you off him. If this is your first exposure to the author, pick a different title, something like Ghost Story or If You Could See Me Now, to get a better feel for Straub closer to the top of his game.