Well, I've always liked the explanation that it was a dream. Whereas, most of the time, when the author pulls the 'it was all a dream' card it feels like a cop-out, in this case I think it's still an incredibly interesting story.
It gives you a glimpse into Jake's psyche, and shows you just how incredibly messed-up he is at this point in the war. How much he desperately wants there to be an easy way out, but in the end, he knows there isn't one.
One of my favorite parts is when he's trying to explain to Tobias/Elfangor that he could win the war without making sacrifices, if only he just had the chance to do it all over again. And Tobias says, <You know better than that.>
I think, interpreting that as Jake saying it to himself, it basically sums up his entire psyche in a nutshell. He wants to fight a war without bloodshed, but, well, he knows better than that.