I faced a similar situation recently mate. My decision was to go for the Arcade, and I think I made the right one
The 256MB memory card is absolutely ample for saving games on, I've discovered. Since I only play relatively few games - I've picked up The Godfather and Forza 2 very cheap, will be paying for Pro Evo when it comes out, and bar maybe another sports game I'll probably not buy again until the next Forza or Pro Evo
The hard drive isn't so important for guys like us. Are you arsed about downloading demos and videos to your hard drive at this stage? No, you just want the console to play games
And you can connect to Xbox Live perfectly fine to play your mates too. You don't get the fancy HDMI cables, but you get what makes it work. So as long as you have an internet connection, you're sorted. You need something to save your gamer tag on, but your memory card is fine for that. You'll have to purchase Xbox Live gold membership to play against your mates, but you only get silver for free on all consoles anyway, to my knowledge
My tactic is to make this last me for a couple or so years, and then migrate to a PS3 when I can afford it, which hopefully by that point will be slimline too. If worst comes to the worst, you can always buy a seperate hard drive, and any fancy cables. But if you can get an Arcade for £100 or so, that's my advice
I've noticed these fanboys can get quite sniffy if you're not buying all the top end gear straight away... just ignore them!