What does he mean by the next sentence?
I shouldn’t laugh if she’s crazy.

7 -year- old boy and boy’s older sister are on the beach.
Boy: Ha, Ha, Hee. That lady’s hiney is showing!
Sister: He is wearing a thong. She knows her hiney is showing.
Boy: I shouldn’t laugh if she’s crazy.

The way I read it, the boy is guessing that the woman is crazy because she is deliberately showing her “hiney”. If the woman is crazy then the boy ought not to laugh at her (because she cannot help her crazy behaviour).

I don’t see any more in it than that, but I am not 100% certain…