I had similar problems a few years ago. Turned out that Win98 and ME didn't like the fact that I had installed over 512MB of system RAM. It caused the floppy drive to work erratically and as well as strange system "pauses" that sometimes lasted for several minutes. It only began to work properly again after some creative registry hacks that turned the additional RAM into a disk cache as Win98 and ME weren't designed to access over 512MB of RAM.
[EDIT] I think 512MB was the limit....may be more or less, but anyway, I had exceeded the max that Win98 or ME could use.
