| Stretching the metacarpo-phalangeal joint (your knuckle) will cause any air bubbles in the synovial fluid (a clear liquid which lubricates the joints, and contains 15% Carbon Dioxide) to create a low-pressure zone within the joint and implodes almost instantly after drawing out water and CO2 causing a loud crack.
This principal is cavitation and is the same reason why a boat propellor produces so many bubbles while spinning and why bubbles appear when you first open a bottle of soda. (The collapsing vacuum that results in the audible crack works the same way thunder occurs after a lightning strike)
Some doctors will contend that this will not cause arthritis directly as genetics are a more likely factor. However, if it already exists chronic knuckle-cracking will likely make it worse (it probably won't help your social standing either)
Abridged source: Cecil Adams at the straightdope.com | 
