As for fiction, I don't know how much you remember of your childhood, but fiction and reality are inherently blurred to a child, because they do not yet truly grasp much of reality. To a seven year old, you can really get to a giant's castle with magic beans; and there are mermaids under the seas while witches live in candy houses in the woods. Even if you teach a child that babies come from sex and thunder is superheated air from an electrical arc, they are likely to prefer to believe in the stork and the bowling angels anyway, because those are more accessible, more wonderful concepts to a child.
....I explained the thermodynamics of lightning and thunder to my daughter when she was 3. I figured it was less scary than "there are supernatural beings in the sky hurling large objects around".
That said, I'll echo some of the other opinions in here that you just can't be totally, brutally honest with a child. There's entirely too much that goes on in the world on a daily basis that would traumatize them.
I don't hide science from them because in my mind, science isn't scary. PEOPLE are scary. Science can be studied, understood, predicted and ultimately controlled. People will snap for no fucking reason and gun down a room full of random people. Or abduct, rape and mutilate a child. Or knowingly send thousands to their deaths in the name of a few bucks. That's the kind of stuff I shield them from until they're older. Once they're older, I'll be happy to show them what a crapsack world we live in, because I don't want them to be like their mother, who hides from the news of the world because she just can't cope with it.
As far as Santa Claus....I don't see the harm. As they get older, they'll develop their own doubts, both from things their peers say and from their own probing of the internal logic and finding holes in it ("So...how does he cover an entire time zone in one hour, when the radar thing on the TV only shows him in North America?"). I suppose in a way, it actually encourages critical thinking if the parents allow the child to figure it out on their own. I think what you're gonna get out of it is determined to a large extent by the child themselves. If they're naturally disposed to critical thinking, they're gonna figure it out quick. If they adhere to a myth easily and determinedly and ignore evidence to the contrary....well, they can find solace in the Church.
Where I have a quandary is a different but related area. I'm Taoist, my wife is Unitarian. Our daughter receives a small amount of religious education at her mother's Unitarian church (which is essentially no religious education at all). But, we recently had to switch her daycare to one which is run by a Methodist church and includes "chapel" and "choir" once a week and has a kind of constant low-level background noise of religion in it. So now my daughter is taking to religion like a fish to water, and it makes me *extremely* uncomfortable. The day is going to come when she discovers that Daddy doesn't believe in Dead-Guy-On-A-Stick-In-The-Sky and hopefully isn't going to be traumatized thinking that I'm going to burn in Hell. I don't want to be anti-religious, and I want her to be free to choose whatever denomination/faith she wants. But she just turned 5. At this age, it's not free choice, it's indoctrination. It's only for another 9 months or so and then she'll be in public school. But it still bothers me. And our son will be there for at least another 3 years.