If the system is not behaving, either delete knoppix-data.img or move it out of
/mnt-system/KNOPPIX/ and reboot.
If I do so, I lose free space for persistent memory (=pm):

a) flash-disk Installation of my CD on a 4GB USB stick
b) after first boot Knoppix offers 3.3GB for pm, I selected 2GB
c) deleted 'knoppix-data.img'
d after next boot Knoppix offers 1.3GB for pm, I selected 1GB
e) deleted 'knoppix-data.img'
f) after next boot Knoppix offers 0.3GB for pm, I selected 0.2GB

Therefore you can only delete 'knoppix-data.img' after booting with cheatcode "knoppix noimage"

Step 2 and 3a isn't necessary. The contents of your just created update.tar.gz is allready within the old knoppix-data.img.

Now I did it in single steps and all went well:
1. create 'update tar.gz' within '/mnt-system'
2. reboot (cheatcode "noimage") and delete 'knoppix-data.img'
3. reboot and create new pm
4. reboot and move 'update.tar.gz' to '/mnt-system/KNOPPIX/'
5. reboot and move 'update.tar.gz' to '/mnt-system' or store it anywhere else

Greetings Werner * http://www.wp-schulz.de/knoppix/summary.html
Own Rescue-CD with Knoppix (Knoppix V6.7.1 remaster)