While I'm not planning on doing any Cloud "hosting" I am setting up something with an iscsi backend with Xen running on dedicateds. My question is, I/O operations will be done on the iscsi, but does the CPU in the dedicateds matter? Will they need SCSI disks, or will simple sata disks be okay (think a lot of reads, some writes). Do the dedicateds require huge amounts of ram, or it doesn't really matter (ala Google model)

iscsi is just the transfer protocal, it has nothing to do with the disks..
But it does require seperate switches from your regular network, and network cards that support iscsi.

The overall I/O really depends on the speed of your iscsi network, matched with the IO of the drives.. For example, if your ISCSI nic is only 1Gbps, a budget SATA drive is more than adiquate. anything lile 2Gbit/4Gbit+ iscsi needs decent drives like raptors.

And your RAID configuration is also important... Typically RAID10 provides best speed over redundancy at the cost of drives.
And seeming you can get 1.5Tb drives really cheap now, cost of storage is next to nothing....

Ontop of that, you do still tend to need File Storage management, thats where the real expense comes in... For managing multi-server Disk and file read/write, otherwise you end up with file curruption/overwrites. we use Sanbolic for our replicated file storage, but ours is over fibre..

We also use network card bridging to loadbalance our fibre traffic, effectively doubling available bandwidth but still limited to overall storage I/O.. You can do the same thing with ISCSI...