"Red Nails" is one of those odd stories which is, as you rightly say, full of flaws, but which also has some peculiar strengths, some of which are connected to your comments, and are things which are scarcely noticed most of the time. There is a similarity here between this story and "The Jewels of Gwahlur", a decidedly secondary tale both of the redoubtable Cimmerian (how's that for a cliche?
) and "Red Nails", in that Howard varies in both these stories between an eerie atmosphere and setting and some deliberately tongue-in-cheek approaches to it all... including Conan himself. I am always reminded of the line in "Gwahlur" where Muriela attempted to "go into the usual clinch" when Conan shows up to rescue her. Their situation is certainly dire, yet even the barbarian has grown a bit irritated by such behavior, it would seem. The bit of insult Conan throws at the poor dragon is another such instance of Howard deliberately going over-the-top in much the same way he did in his regional humor tales about Breck Elkins, "Jeopardy" Grimes, etc., or some of his fight tales about Sailor Steve Costigan and the like. One sees more of this, for instance, when Conan comes across Olmec in that peculiarly nasty yet unavoidably (and, I would argue, again deliberately) comical torture device. It is a rough, earthy sort of humor one doesn't often see with Howard's "straight" heroes, but which does, inevitably, crop up from time to time; very much the sort of frontier humor Howard himself found so amusing. It is broad, and shifts things distinctly toward the "tall tale" rather than straightforward fantasy... but I find it sometimes rather refreshing as a result (at least when he doesn't overdo it).
As for the "dragon", or dinosaurian creature at the beginning... the focus there really isn't about that apparently final member of a long-dead-but-sorcersouly-revived species, but about the interaction between the stubbornly amourously inclined Cimmerian and the equally stubborn and decidedly uninterested piratical companion Valeria; and, again, the entire sequence is handled with a great deal of comic intent. This actually, I think, contrasts rather well with the eeriness of the next setting, when they are introduced to the haunted city of Xuchotl.
Incidentally, I would argue that the idea that the inhabitants are all mad is less a bit of editorializing on Howard's part and more an example of Conan's own reaction to the obviously neurotic and decaying culture he encounters there. I would also argue that the dragon being used as a way to keep the inhabitants (or at least the lower class... the elite seem to know that the one Conan and Valeria meet up with was the last of its kind, if memory serves) works because it is precisely the sort of cynical playing on superstitious fears that such people would tend to invent, and then to continue to carry on long after it was no longer necessary... another sign of their decadence and approaching dissolution.
Tascela is, to me, a not entirely successful creation, but an intriguing one. She seems to have deliberately begun the feud, and to have kept it going; apparently out of a wish for some particularly repugnant amusement, much like torturing lab rats to see which ones will eat the others. Howard always tended to make his sorcerous women among the most cynical of the lot (a very odd thing, considering his comments on Cabell's
Something About Eve), and Tascela is right up there with Salome or the semi-human witch in "Worms of the Earth" when it comes to this character trait. (Oddly, I don't find her reaction to Tolkemec that pulpish in itself; to me it has always hinted both of a certain reluctant fear she feels toward him, coupled with a strong curiosity and desire to know the secrets he has beheld... whether to relieve her continuing ennui, or to further her sorcerous powers, I am not certain if even she could say.)
However, I will agree that there are frequent patches of bad writing in this tale, not to mention various conceptual flaws; but I think much of this is redeemed by that pictorial element you mention (which is really quite impressive; the descriptions of the city in the early portions of the narrative would almost make it worth reading just for that element alone, they are -- to me, at least -- so poetically and imaginatively impressive), as well as the unusual elements of humor in an otherwise starkly grim and even brutal tale; and for that contrast between the two as well.
By the way... I have read this story in numerous editions over the years: the comic book adaptation by Barry Windsor-Smith (which is how I first read it... well worth looking up, if you've not seen it); the Lancer Conan set (the first purely prose edition I read); the Berkley restored version; the Donald M. Grant edition; and the more recent Del Rey tpb The Conquering Sword of Conan. It is still far from my favorite story personally, but nonetheless I rank it rather high in the canon for various reasons, some of which I've addressed above.