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I called the trace operation unphysical because it is something we do by fiat. I agree there is something going on, but we in effect "trace over it." It is rather similar to the problem of metric back reaction with Hawking radiation. This is something one imposes, using classicality of spacetime, which is suggestive of some quantum gravity process. In fact the problem of measurement in quantum mechanics and the problem of quantum black holes share some remarkable similarities.
I am not as heavily marinated in problems on the foundations of quantum physics as apparently you are, and certainly not as much as Chris Fuchs. I do find something odd about this. I maintain that quantum mechanics is as simple a physics as one could ever want. It involves state spaces that are linear, linear operators, basic vector space operations of diagonalization, eigenvalues and eigenvectors and so forth. Nature could not possibly be any simpler. The problem is not the quantum but the classical. The existence of a classical world is the big mystery. All of the strangeness about quantum mechanics stems from the fact we observe things from a classical perspective.
I think it comes down to the fact that quantum mechanics describes states that have a representation in configuration variables, but quantum states or Hilbert space has no explicit dependency upon them. As a result we make measurements, such as "the electron appeared here" according to such variables in a way that quantum mechanics is blind to, or at least blind to as we understand. We measure these according to classical systems or represent them according to classical information.
If one were to quantize the observer, which I think requires understanding how quantum mechanics "builds up" the classical world, this seems to me to get into the problem of self reference. A self referential physics, one where maybe quantum numbers are Godel numbers, strikes me as the last possible theory after all else has been exhausted. We may well be heading in this direction though, with what ever dragons might appear.
Cheers LC