Type 2 diabetes is strongly associated with nonalcoholic fatty liver disease (NAFLD), a spectrum of liver damage that ranges from relatively benign hepatic steatosis to potentially fatal cirrhosis. The severities of insulin resistance and liver damage parallel each other, with the greatest prevalence of cirrhosis occurring in cirrhotics. However, it is unknown whether one of these conditions causes the other, or if both are consequences of another process. Experimental evidence suggests that both insulin resistance and NAFLD result from a chronic inflammatory state. The mechanisms driving this chronic inflammation are unknown but might include the egress of products from intestinal bacteria into the portal blood, liver, and systemic circulation to trigger a sustained inflammatory cytokine response in genetically susceptible individuals. More research is needed to evaluate this hypothesis and to determine the benefits of treatments that interrupt this pathogenic cascade.