My dad could tell a good yarn. He would sit at the back of church and tell stories to make people laugh as they arrived for mass. He would also tell stories to the little people to keep them entertained.
To spin a good yarn means that the story is not all that truthful. A story that entertains but is not necessarily based on fact. It leaves the listener asking “really?” Like I said my Dad could spin such a good yarn that people did believe what he said. With the added factor of a bit of gossip mixed in. People were not sure what was the truth and what was not.