Germ cells in the mouse embryo can develop as oocytes or spermatogonia, depending on molecular cues that have not been identified. We found that retinoic acid, produced by mesonephroi of both sexes, causes germ cells in the ovary to enter meiosis and initiate oogenesis. Meiosis is retarded in the fetal testis by the action of the retinoid-degrading enzyme CYP26B1, ultimately leading to spermatogenesis. In testes of Cyp26b1-knockout mouse embryos, germ cells enter meiosis precociously, as if in a normal ovary. Thus, precise regulation of retinoid levels during fetal gonad development provides the molecular control mechanism that specifies germ cell fate.