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I probably should have said I have emulated a LiveCD
on a USB formatted with fat32. My Bad.

I've made a nice LiveCD on Fat32. Works very nicely, but no persistence of course.
I think it's likely the LiveUSB may have to be on ext2 or ext3.
A GUI for making the LiveUSB is apparently in...

PCLinuxOS-LXDE includes (at least the makings of ) an up-and-coming LiveUSB
that I think is worth watching.
Similar in may ways to Knoppix 6 with LXDE and persistence,
at least potentially....