Okay I have solved the problem(sort of) THE HARD WAY-by trial and error.

By the way,I have the 'poor man's install' so the xf86config is not saved. Anyone knows how to save it with the cd setup?

The steps:
1. had to delete the myconfig files and the persistent home(using win9.
2. boot to knoppix.This time the usb mouse worked.
3. do KNOPPIX/configuration-both persistent home and config files.
4. reboot knoppix.USB mouse now works.