True. If they have a genetically-modified smallpox then all the vaccination in the world is likely useless, and we're all doomed. I think that's a fairly unlikely possibility, given that "Dr. Germ" is reportedly far from an evil genius -- she's just evil. OTOH, Saddam does have a track record of seeking out the best and the brightest for his "special weapons" programs (remember Dr. Bull, of "Supergun" fame), so, you never know.
Alternatively, it could be the source of a vaccine effective against smallpox.
Then again, maybe they really are worried about their camels. It is the Middle East, after all.
Basically, in considering threats, you have to make a comparative judgment about the evidence that each specific threat is credible, the likely damage, and the cost and feasibility of countermeasures. I see too many people on this site running around like chickens with their heads cut off and screaming "Blue Murder!" over remote, hypothetical threats, when a very concrete and much more serious threat is clearly in the public domain.
Mind you, I think this response is, in part, by design of the authorities. Smallpox scares provide people with a justification for worrying about Saddam Hussein and for pushing forward with civil defense, but they are not so concrete that people are actually going to change their lives or eceonomic behaviour because of them. Thus such hypothetical proxy scares (smallpox, dirty bombs, suitcase nukes) address the conflicting aims of the policymaker -- the desire to build needed support for war preparations, with the desire to avoid handing the aggressor a psychological and economic victory.