You need the vehicle for Clay, I'd pull the engine from your 7, and put it in Clays 5. A weekend job.
Sounds like a lot of blow by, (normally blue smoke) Clays is white ( steam) from what you said. Any oil in the water or vice-versa?
Reasoning on your 258. Budget, minimal down time, your 7 isn't going to be a driver for a least 6 months or better.
Another idea , transfer the license to the XJ along with the insurance. I know it's Fallon's jeep, but you need three vehicles. This will give you some time for the swap.
Also a compression check on Clays 5, to see where your at.
The 4.3 swap requires, as you know , the bell housing,radiator, flywheel (unless the 4.3 comes from a S10 with a standard tranny), motor mounts ,a new manifold if carbureted, or figuring out the wiring ,with Fuel injection, along with a $100 fuel pump. The 5 speed would be nice, however, you might not be able to adapt the Dana 20 to it, or finding a Dana 300 and then the adapter ($500. )The 5 speed tranny and the TC that would come with it would need a slip yoke eliminator ($350.) And the driveshaft would still be really short.
1957 WILLYS pickup,
1973 J 4000,
1978 CJ7 DD.
1979 CJ7 360, TH400/Quadratrac.
1980 CJ5 trail Jeep.
1989 YJ the CJ to YJ.