Not sure if its due to Norton or some other program trying to get updates from the internet.
Norton is one that is intrusive.

Try disabling Norton then restart, ensuring no Norton apps are running therefore no updates being fetched.
There is this s/w called DU meter (just measures bytes) or find some other net monitoring s/w so you can see what is talking to the internet.

I have a program that measures usage of the internet, number of kb passing upload and download. During the Lag time there is nothing going through, well nothing big only the standard idle download/upload.
There was a similar problem out there that was not solved yet. I think we may have the same problem.
I will try to describe more into how the problem works.
Upon connecting to the internet, if an internet window is opened, or folders, or msn messenger, all works normally. I can browse the internet with no problems. Msn is different, I can see contacts online offline etc. But i cant "open" a chat window with them.
This lag also causes me to be unable to open other folders, (my Docs, My music etc) or other programs. Paint, notepad etc you name it. Even the Ctrl+Alt+del window doesnt open.
I must remind you, anything that was, prior to connection, open works, eg browsing. The mouse doesnt lag, works normally.

Then suddenly the block is opened. all the programs i've clicked on in frustration open. multiple notepads, paints, my docs. or single programs.
This is a very strange problem that has never happened before, never come across it, and its difficult finding anyone else out there with the same problem. Which is how I came to this site, as there was that other person with the problem.

My guess is some program is hogging it, and it may now be a case of trial/error. In your first post, what stands out the most is Norton. This is known to be a product that slows down your computer, which is why I suggested what I did. Just ensure it doesnt talk to the net.
If you got a firewall, perhaps you can monitor that and check what programs are connecting and talking to internet. It might give you an idea.

I dont know if Norton is interfering with your chat window, perhaps doing some security check or something.

what type of internet are you using. some modems/routers are set to use the old style PPP authentication where the device doesn't keep you logged in, instead it logs you in as needed, it's a process that's similar to a dial up connection but for DSL.

my internet connection is a student housing type, so I am not exactly sure how it works. I do need authentication to log in, using a similar interface as a modem dialup. All I know is that I plug the cable into the socket in the wall, and into my pc, then open up the login, connect and im on the net. If that helps.
But the lag starts after Im connected, ie if I've pre-opened firefox or IE i can surf the net, just cant open a new program, folder or new internet browser window separate to existing.
I have never had a flood of programs opening all at once, and thought that that would have been an easy fix... seems this problem is pretty rare.

that makes a heck of alot of sense now. my best guess is that there is a program that activates when your computer is connected to the internet like windows update or something else that's self updating, barring spyware or viruses. My money is on windows updates and svchost is maxed out. to check this out, open the task manager and click on the process tab and watch which one is sitting at 99% most often. if it is svc host, restart the computer in safe mode and rename the directory/folder
software distribution
to something else. that folder is in the c:\windows directory. after this is done, restart the computer normally. I recommend you do all the windows updates afterwards as well.

essentially what nidhi said, but for a less conspicuous program.

Sorry guys, even with your help still strange things happen when im connected... Ive figured a way around it, send my computer to standby mode (the shut down menu still comes up and works normally even during lag)
Generally when I wake up the comp it works normally.
Ive given you guys points anyway...

I am having the same problem myself, though my situation is slightly different from the original poster. I run WindowsXP SP2, using Avast Antivirus. No Symantec product is installed. I mainly connect to the internet through my home network (Laptop connected to Router connected PPPoE to the internet) and my Laptop has no problems with this connection. However everytime I take the Laptop to work and connect via Dialup immediately after the computer is connected it stops being able to open new programs until some random point. Sometimes this point is 10+ minutes after the internet connection is established, sometimes its only 2 minutes. Programs that were open before work fine. During this lag time the CPU and internet aren't showing abnormally high utilization.

To me it feels like WindowsXP is launching a process on connection to the internet and is waiting for it to complete before it lets anything else happen. Then this process is crashing or freezing causing XP in turn to freeze until the process recovers. Since it doesn't happen on my primary connection (ethernet cable) it could be this process is not configured or programmed properly and is trying only to get a response through my Ethernet card, and doesn't understand why it can't.