How do I connect 2 netbooks with LAN?

The network cable that connects both netbooks I think needs to be a cross over cable, also the netbook that has the USB PAYG dongle connected needs to be setup for internet connection sharing or to just bridge the connections to share the internet with the other netbook (assuming that's what you're trying to accomplish?)
 
A lot of kit is auto-mdx so if it's it's saying "Limited or no connectivity" then the cable might be OK, but as Wesley said, if you've not got a router connected then nothing is issuing IP addresses.
Follow the instructions on the bottom of the page here:
http://www.howtogeek.com/howto/19249/how-to-assign-a-static-ip-address-in-xp-vista-or-windows-7/

Set one laptop to 192.168.0.1 / 255.255.255.0 and leave the default gateway and DNS server blank as they wont be used.
Set the other laptop to 192.168.0.2 / 255.255.255.0 and again leave the default gateway and DNS empty.

Just remember to set them back to "obtain an IP address automatically" afterward or you may get issues when you do plug it into a router.
 
What a waste of time.

I messed around a bit with the settings but it didn't work. And anyway I can't be bothered with it now. It's way too much hassle considering all I'm trying to do is get 2 netbooks to share an internet connection. Does it really need to be this complicated? :/

Thanks for the help though.
 
Sounds like you have auto-crossover (Auto MDI-X) on at least one of your NICs. Normally if the wrong cable is used XP will say "network cable is unplugged". "Limited or no connectivity" is normal when IP addresses have not been received automatically via DHCP or set manually. Do not set IPs manually as instructed above (they are slightly wrong) set them both to auto and let XP Internet Connection Sharing sort it all out for you.

First get the dongle and internet working with NB1. Then with the cable plugged in on both NBs setup ICS on the NIC in NB1; part of the setup will assign it a static IP and enable a mini DHCP server to send settings to the other NB. Now on NB2 "repair" the connection; this will let it get suitable IP, gateway and DNS addresses all of which it needs for internet. You should now have internet working on both NBs.
 
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