The current limit knob sets the maximum current that the PSU can supply, regardless of voltage. Say, for example, your circuit draws 200mA at 5V. You would set the current limit to a bit over 200mA. If you then accidentally short something, the available current will be limited to just over 200mA and minimise the damage that you do to your circuit.
Because you are trying to draw more that the current limit setting, the output voltage will collapse to whatever voltage is needed to maintain that current. If it is a short circuit, then the voltage will drop to very nearly zero, just the voltage of the resistance of the leads and your short circuit - the PSU is now in constant current mode (rather than constant voltage).
Constant current mode can be used for other things, such as charging a NiMh battery. You would adjust the current knob to give the desired charge current, and set the voltage knob to the battery fully charged voltage, so that the current will drop at full charge (that's not a perfect science by the way, just an illustration).
Current limiting to prevent or reduce accidental damage is the main use though.
P.S. Be careful trying to use constant current mode for driving LEDs and similar. Most PSUs have an output capacitor - in constant current mode, with no load, this will charge up to the voltage knob setting and then when you connect the LED it will discharge into the LED, causing a nasty current spike and probably killing it. To use constant current mode for things like this, set the voltage to zero, connect the load, adjust the current knob to the desired current and then slowly bring up the voltage until the PSU goes into constant current mode (the voltage stops rising as you turn the voltage knob further).