I had this same problem recently,
I was given a Schema from a third party company who were returning an xml structure from a webservice. I then wanted to deserialise the response and store the information into a database with NHibernate.
No problem I thought I'll just use xsd.exe and I'll have my classes. Unfortunately this was not to be. Xsd.exe failed with exactly the same error you are getting. This is because it is unable to resolve circular references.
I spent a good few days looking at alternatives until in the end I wrote my own class structure to the schema and was able to deserialise perfectly. The answer here is to write your own C# classes and decorate them with the appropriate attributes.
Save yourself some time and heartache and don't continue to try and generate the classes you need automatically in the end although time consuming the classes you write won't make the compromises that most tools (which don't work perfectly) will make you make.
Took me about 3 days to write the class structure (it was large) but I ended up with a quality solution.
One thing is certain you will not be able to use xsd.exe and most other tools I tried after googling this either did not work properly or were buggy.