I don't know whether Dd believes that Santa is real or not, but she loves the whole fantasy and the whole process so much, that we do it. She talks about leaving a note for Santa at our house, with grandma and grandpa's address, so he knows where she is on xmas eve. She describes how he'll come in, and she leaves cookies and cheese (has anyone seen that commercial) and milk. She is just so full of the wonder and mystery of it that, for now, it works for us.
I do remember, however, being really crushed when I found out Santa wasn't real. I was 7, I think, and my dad and I were driving out on a camping trip. He thought I already had figured it out, and just said something casual in conversation referring to the fact that Santa isn't real, and I freaked out. Part of me had probably known, but I loved the fantasy of it, and didn't want to be disillusioned. From that year on, we went right back to the fantasy, and even in my teen years, when I would thank him for a gift from santa, he would feign ignorance, and tell me not to thank him, bcs it was from santa. To this day, my dad still sends me gifts from Santa.
I believe that the reason kids believe in fairy tales and fairies is that we (society) haven't convinced them yet that they are mistaken. I think that they can see and know things about the world that we can't. Who says all imaginary friends don't start out real? I love my dd's "imagination" and fantasy tales.