The <xsl:strip-space> element deletes whitespace between elements that may have been added during the creation of the XML file as well as whitespace that exists within elements that do not contain any text.   It does not remove whitespace within elements that also contain text as XML considers such whitespace to be significant.
It simply makes the file more compact.   
It should not affect any text or entity references such as you indicate.   It may be that the XSLT processor you are using behaves in a non-standard way.     In any event, there would no harm to omitting it from the stylesheet.
Have you tried using the decimal form of these entities, &#147; and &#148; instead of the named version?

Michael J. Fox
Assistant Director for Library and Archives
Minnesota Historical Society
345 Kellogg Blvd West
St. Paul, MN 55102-1906
651-296-2150  (phone)
651-296-9961  (fax)
[log in to unmask]

-----Original Message-----
From: Loren Scherbak [mailto:[log in to unmask]]
Sent: Tuesday, December 04, 2001 10:12 AM
To: [log in to unmask]
Subject: Cookbook stylesheet question

Hi all,
We are slowly getting up to speed with the Cookbook. I have been trying to understand the stylesheets. I have one very basic question. Why is the line <xsl:strip-space elements="*"/> included?  It seems to mess up my use of special character codes like &rdquo;  and  &ldquo; for quotes.
Loren Scherbak
Archives of American Art
Smithsonian Institution
[log in to unmask]