If you want a long and interesting/entertaining explanation of this (and an additional bit of information at the bottom of the post that has absolutely nothing to do with Chinese characters...you've been warned) have a look at Cecil Adam's explanation on The Straight Dope.
You can see a more detailed explanation on our old friend, Wikipedia.

Why am I offering you these opportunities to go chasing after the 'real' meanings of a Chinese word? Because in an article written by John Ortberg in the Leadership Online Journal, I came across this rather extraordinary statements, which just goes to prove, I suspect, the reality of the Chinese Whispers game.
'It is a little known fact that in Chinese, the word crisis is made up of two characters: "life" and "stinks."'
I suspect it's a 'little known fact' because it's pretty much incorrect - or, at best, a very loose translation! Which goes to show that if you're going to put information on the Net, or preach it to your congregation, it's best to get it right...