Gatsby says this important quote to Nick in Chapter 4, when he tells Nick about the "truth" of his background so that Nick will not be taken in by the elaborate fictions he has heard about Gatsby and his rise to wealth. However, in spite of Gatsby's protestations of veracity, it becomes clear that Gatsby is merely spinning yet another fiction for the ears of Nick. Although Nick is not entirely sure, what clinches his belief that Gatsby is lying is the following phrase:

"After that I lived like a young rajah in all the capitals of Europe--Paris, Venice, Rome--collecting jewels, chiefly rubies, hunting big game, painting a little, things for myself only, and trying to forget something very sad that happened to me long ago."

Note the obvious rehearsed nature of this sentence. Firstly there is little "big game" in the cities of Europe, nor are there many rubies to be found, except in shops. Nick has to "restrain his laughter" because, as he says:

The very phrases were worn so threadbare that they evoked no image except that of a turbaned 'character' leaking sawdust at every pore as he pursued a tiger through the Bois de Boulogne.

Gatsby is so concerned to perpetuate the mystique that surrounds him and to downplay his humble origins that he shares this "truth" with Nick in confidence, only to spread yet more clichés and ridiculous ideas, and it is only later on that Nick finds out the real truth about Gatbsy's rise to wealth and fame.

Nick has to restrain his laughter because Gatsby's story is so outlandish and ridiculous and, seemingly, impossible. At first, Nick "suspected that [Gatsby] was pulling [his] leg," but he eventually becomes convinced by Gatsby's sincere countenance and tone that the man is not trying to be funny. It's as though Gatsby has concocted the most romantic story possible, cobbling together all kinds of scenarios concerning everything from a dead family from whom he inherited a "'good deal of money'" to tales of war heroism. He says that his family has come from the Midwest, but when Nick asks where, Gatsby tells him, straight-faced, "San Francisco": a city most certainly not a part of the Midwest! Gatsby has said that he's going to tell Nick "God’s truth" about himself, though one would have to be a total ninny to actually believe the details. Nick says that listening to Gatsby describe his so-called past "was like skimming hastily through a dozen magazines." It's like a fairy tale, full of ridiculous and incongruous details, that the listener is not supposed to question; it is so ludicrous that a grown man would present such crazy stories as his own that Nick must work to restrain his laughter.