Good idea, and not just for smut. Your eyes must be younger than mine, though, 9 pt is too small for me!

You can get nearly as much space saving without losing paragraphs (assuming the author left a blank line between them) if you use an intermediate code for paragraph breaks. For example:

Change all ^p^p and ^p ^p (that's ^p^p with a space after the first p) to <> or any other character(s) that do not appear in the text.

Then change all remaining ^p to a space, change <> (or whatever) back to ^p^p (no spaces) and continue as you suggest. Sometimes there are multiple ^p's in a row, so you may want to change ^p^p^p to ^p^p at the end.