Why can't I install Windows on my USB drive?
A collection of limitations (both hardware and software)
currently prevent Windows from booting and running off a USB drive.
Some of them are described in
this whitepaper from WinHEC 2003.
Another reason not mentioned in this paper is that during any hot-plug
operation, the USB bus is completely reinitialized.
Windows really doesn't like it when it loses access to its boot device.
Imagine, you plug in a USB camera, the USB bus reinitializes, Windows
loses access to the boot drive, and *oops* the kernel needs to page in
some data and it can't.
Rats.
But who knows, someday maybe it will work.