Solution found on the MS VM forum:
http://blogs.msdn.com/virtual_pc_guy/archive/2005/09/19/471612.aspxBy installing SETI@home on the physical machine, evidently the processor is not allowed to go into a lower power/performance mode defined by the ACPI settings. This is despite my setting the power settings to max everything.
I can easily recreate the problem by clicking the Pause button on the SETI application, noting that Notepad is slow, clicking Resume on the SETI app, then seeing Notepad speed up. All of the Windows Update stuff works fine as long as SETI is running.