According to the Encyclopedia of Word and Phrase Origins, 4th Ed. by Robert Hendrickson (ISBN-13: 978-1-60751-235-6):
DARE traces this Western word for someone given to exaggeration, or a liar, back to 1901 and says it derives from the name of the Hassayampa River in Arizona; the river's name, in turn, probably coming from a Yuma Indian word. The term was first applied to old prospectors with wondrous but untruthful stories. Why was the river associated with liars and lying? According to the Dictionary of American Folklore: "There was a popular legend that anyone who drank of the Hassayampa River...would never again tell the truth."