I don't think David Lynch would utilize dreams as a plot device. I think he would consider it too easy, a cheap slight of hand technique that is both well-worn and beneath him. Mr. Lynch prefers depictions of madness. Fantasy, neurosis, and delusional
psychosis are simply matters of degree to him. Out of this backdrop, I think Diane Selwyn was schizophrenic and her mental illness stemmed from being abused as a child by her father's best friend. Her form of schizophrenia does not involve acting out as different
persona but instead involves delusions of being different persona. She comes to Hollywood from Canada believing that she won a jitterbug contest that never really happened and not only are her dreams of success in Hollywood dashed, but she in involved in a short-lived lesbian relationship with the character L.J.
DeRosa which terminates with Diane moving out to an adjoining apartment. Virtually everything else in the movie is simply the product of Diane's psychosis. As noted by virtually everyone, there are themes of duality everywhere.
The "Silencio" scene in this context is better explained. It represents a brief interlude of lucidity by Diane. Her alter-ego personae of both Betty and Camilla (who are really nothing more than multiple personalities of herself) upon hearing the Fado-like singing of the Hispanic singer are crying because Diane is intensely sad upon lapsing back into harsh reality from the softly focused numbness and comfort provided by her delusional world.
David Lynch relishes the ultimate duality: that the cut-throat, corrupt, lurid, seedy, and fake world of Hollywood is best viewed from the distorted lens of an insane person, as if the insanity acts as an ironically effective filter for all of the distortion existent in the "real world". This, of course, has been a recurring theme in much of David Lynch's work, all the way back to "Eraserhead". - (FSonicSmith)
All that "Blue" reminds me of electricity. My guess is that the main story is about
schizophrenia or Dissociative Identity Disorder and electro-shock (convulsive) therapy that was popular in the fifties. Many of those who had that done to them lost their memory and attempted (or committed) suicide. Betty has won a "jitterbug" (neurotic) contest. She comes from "Deep River, Ontario." (Look it up on
Google). Here's a quote: "The Utopian town where our atomic scientists live and play has no crime, no slums, no unemployment and few mothers-in-law." This is a strange place. Deep River is a Utopian attempt to create a happy environment where all is ordered for the best.