Here you can learn much about the Water Crystal: The Crstal of Water is in the Walz Tower; Walz Tower is to the north, and the entire town's water supply comes from there; Through amplification by the machine the Crystal purifies the waters; and a strange and shy creature called Garula lives near the Tower.
There's not much to do here other than chat. The magicks aren't of much value now becuase you can't use them yet, but do stock up on the Iron goodies and a couple of Long Swords. Don't bother with the axe for now because, like the magicks, you can't use it yet (unless, of course, you revert back to the Bare class). You can find the SilvGlasses (an accessory that protects against blindness) in a pot in the house furthest to the left. You have to use the stairs to enter the water (make sure to talk to the frogs!), then go to the left and enter the house. Lastly, you can check out a lumbering, but peacful, beast called Garula in the lower right hand corner of the town.
The first thing you need to do when you arive at the Castle is to speak with King Walz (just walk straight up). After a brief argument between your party and the King, another meteor comes crashing down near the Walz Tower. King Walz, having no more time for idle chit chat, hurries off with his entourage to investigate. Instead of following the King right away, spend some time looking around the Castle!
From the throne, head to the right to find the King's Chambers: not much here though. Head back to the throne room and then down to the main foyer. From here head through the door on the right, and then head to the steps in the lower right corner of this room to find the Storehouse. The Storehouse has three goodies for you: a Tent, a Phoenix Down, and 490gp. Head out of the Storehouse and loop around to the other set of stairs you didn't take yet to get to the 3rd floor. Not much here except for some scholars on the subject of crystals. You can, however, step on that small round thing on the floor to open up another room with another scholar hiding inside (nothing of value in here except info...).
Now, if you want, you can head all the way back to the main foyer and take the other steps down to the 1st floor. From here, you can head left to reach the dungeon. Make a point of not (I repeat, not!) releasing the Lone Wolf pickpocket from his jail cell - he shows up later on to steal some treasure if you release him now.
Back in the main 1st floor room, you have three other options: you can go down into the basement and hope you don't run into the Harpy (the Harpy will kill you at this point in the game) trying to get the last few treasures; you can exit out of the lower right door which heads to the Walz Water Tower and the Shiva summon; or you can hit the switch on the floor and open the secret door that lets you go swimming (I can't see another use for it besides as an entrance if you fall down from one of the waterfalls outside). I recommend that you wait until later for all three as Harpy will tear you up, and so will Shiva when you are at level 10-12, unless you get super lucky.
You should head to the Water tower to check it out and fight a few Elf Toads to learn their Toad Song Blue Magic (they have to be alone, so kill all the enemies but one Elf Toad and be patient). While you're in the Tower you can also steal a nice Mythril Sword from the Ice Soldiers for your Knight! The only other thing of value that you learn in this castle is that there is something called the Library of Ancients to the west of Walz that has many useful books.
One you've finished getting your armor rusty, you'll need to towel yourself off, and then hop aboard the dragon and head to the Walz Tower.